UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2006
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________________ to ______________________
Commission file number: 0-18953
AAON, INC.
(Exact name of registrant as specified in its charter)
Nevada 87-0448736
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(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
2425 South Yukon, Tulsa, Oklahoma 74107
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (918) 583-2266
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.004
-----------------------------
(Title of Class)
Rights to Purchase Series A Preferred Stock
-------------------------------------------
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. |_| Yes |X| No
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or 15(d) of the Act. |_| Yes |X| No
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. |X| Yes |_| No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the
Securities Exchange Act of 1934).
Large accelerated filer |_| Accelerated filer |X| Non-accelerated filer |_|
Indicate by check mark whether the registrant is a shell company (as
defined by Rule 12b-2 of the Act. |_| Yes |X| No
The aggregate market value of the common equity held by non-affiliates
computed by reference to the closing price of registrant's common stock on the
last business day of registrant's most recently completed second quarter (June
30, 2006) was $245,000,000.
As of February 28, 2007, registrant had outstanding a total of 12,334,677
shares of its $.004 par value Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of registrant's definitive Proxy Statement to be filed in
connection with the Annual Meeting of Stockholders to be held May 22, 2007, are
incorporated into Part III.
TABLE OF CONTENTS
Page
Item Number and Caption Number
PART I
1. Business. 1
1A. Risk Factors. 4
1B. Unresolved Staff Comments. 6
2. Properties. 6
3. Legal Proceedings. 6
4. Submission of Matters to a Vote of Security Holders. 6
PART II
5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases and Equity Securities. 7
6. Selected Financial Data. 9
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations. 10
7A. Quantitative and Qualitative Disclosures About Market Risk. 18
8. Financial Statements and Supplementary Data. 19
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure. 19
9A. Controls and Procedures. 19
9B. Other Information. 21
PART III
10. Directors, Executive Officers and Corporate Governance. 22
11. Executive Compensation. 22
12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters. 22
13. Certain Relationships and Related Transactions. 22
14. Principal Accountant Fees and Services. 23
PART IV
15. Exhibits, Financial Statement Schedules. 24
PART I
Item 1. Business.
General Development and Description of Business
AAON, Inc., a Nevada corporation, was incorporated on August 18, 1987.
The Company (including its subsidiaries) is engaged in the manufacture and sale
of air-conditioning and heating equipment consisting of standardized and custom
rooftop units, chillers, air-handling units, make-up air units, heat recovery
units, condensing units, coils and boilers.
Products and Markets
The Company's products serve the commercial and industrial new construction and
replacement markets. To date virtually all of the Company's sales have been to
the domestic market, with foreign sales accounting for less than 5% of its sales
in 2006.
The rooftop and condenser markets consist of units installed on commercial or
industrial structures of generally less than 10 stories in height. Air-handling
units, chillers, coils and boilers are applicable to all sizes of commercial and
industrial buildings.
The size of these markets is determined primarily by the number of commercial
and industrial building completions. The replacement market consists of products
installed to replace existing units/components that are worn or damaged.
Historically, approximately half of the industry's market has consisted of
replacement units.
The commercial and industrial new construction market is subject to cyclical
fluctuations in that it is generally tied to housing starts, but has a lag
factor of 6-18 months. Housing starts, in turn, are affected by such factors as
interest rates, the state of the economy, population growth and the relative age
of the population. When new construction is down, the Company emphasizes the
replacement market.
Based on its 2006 level of sales of approximately $231 million, the Company
estimates that it has a 13% share of the rooftop market and a 1% share of the
coil market. Approximately 55% of the Company's sales now come from new
construction and 45% from renovation/replacements. The percentage of sales for
new construction vs. replacement to particular customers is related to the
customer's stage of development.
The Company purchases certain components, fabricates sheet metal and tubing and
then assembles and tests its finished products. The Company's primary finished
products consist of a single unit system containing heating, cooling and/or heat
recovery components in a self-contained cabinet, referred to in the industry as
"unitary" products. The Company's other finished products are coils consisting
of a sheet metal casing with tubing and fins contained therein, air-handling
units consisting of coils, blowers and filters, condensing units consisting of
coils, fans and compressors, which, with the addition of a refrigerant-to-water
heat exchanger, become chillers, make-up air units, heat recovery units and
boilers consisting of boilers and a sheet metal cabinet.
With regard to its standardized products, the Company currently has five groups
of rooftop units: its HB Series consisting of four cooling sizes ranging from
two to five tons; its RM and RN Series offered in 21 cooling sizes ranging from
two to 70 tons; its RL Series, which is offered in 15 cooling sizes ranging from
40 to 230 tons; and its HA Series, which is a horizontal discharge package for
either rooftop or ground installation, offered in eight sizes ranging from seven
and one-half to 50 tons. The Company also produces customized rooftop products
with direct (MN Series) and indirect (DT Series) heating in sizes as required.
-1-
The Company manufactures a Model LL chiller, which is available in both
air-cooled condensing and evaporative cooled configurations.
The Company's air-handling units consist of the H/V Series, the modular (M2)
Series and a customized NJ Series.
The Company's heat recovery option applicable to its RM, RN and RL units, as
well as its M2 and NJ Series air handlers, respond to the U.S. Clean Air Act
mandate to increase fresh air in commercial structures. The Company's products
are designed to compete on the higher quality end of standardized products.
Performance characteristics of its products range in cooling capacity from
28,000-4,320,000 BTU's and in heating capacity from 69,000-6,000,000 BTU's. All
of the Company's products meet the Department of Energy's efficiency standards,
which define the maximum amount of energy to be used in producing a given amount
of cooling.
A typical commercial building installation requires a ton of air-conditioning
for every 300-400 square feet or, for a 100,000 square foot building, 250 tons
of air-conditioning, which can involve multiple units.
The Company has developed and is beginning to market a residential condensing
unit (CB Series) and air handlers (F1 Series) as well as boilers (BL Series).
Major Customers
The Company's largest customer last year was Wal-Mart Stores, Inc. Sales to
Wal-Mart accounted for less than 10% of total sales in 2006 and 2005, and were
14% of total sales in 2004. The Company has no written contract with this
customer.
In order to diversify its customer base, the Company has added to and/or
upgraded its sales representation in various markets.
Sources and Availability of Raw Materials
The most important materials purchased by the Company are steel, copper and
aluminum, which are obtained from domestic suppliers. The Company also purchases
from other domestic manufacturers certain components, including compressors,
electric motors and electrical controls used in its products. The Company
endeavors to obtain the lowest possible cost in its purchases of raw materials
and components, consistent with meeting specified quality standards. The Company
is not dependent upon any one source for its raw materials or the major
components of its manufactured products. By having multiple suppliers, the
Company believes that it will have adequate sources of supplies to meet its
manufacturing requirements for the foreseeable future.
The Company attempts to limit the impact of increases in raw materials and
purchased component prices on its profit margins by negotiating with each of its
major suppliers on a term basis from six months to one year. However, in each of
the last three years cost increases in basic commodities, such as steel, copper
and aluminum, severely impacted profit margins.
Distribution
The Company employs a sales staff of 14 individuals and utilizes approximately
87 independent manufacturer representatives' organizations having 104 offices to
market its products in the United States and Canada. The Company also has one
international sales organization, which utilizes 12 distributors in other
countries. Sales are made directly to the contractor or end user, with shipments
being made from the Company's Tulsa, Oklahoma, Longview, Texas, and Burlington,
Ontario, Canada plants to the job site. Billings are to the contractor or end
user, with a commission paid directly to the manufacturer representative.
-2-
The Company's products and sales strategy focus on "niche" markets. The targeted
markets for its equipment are customers seeking products of better quality than
offered, and/or options not offered, by standardized manufacturers.
To support and service its customers and the ultimate consumer, the Company
provides parts availability through eight independent parts distributors and has
factory service organizations at each of its plants. Also, a number of the
manufacturer representatives utilized by the Company have their own service
organizations, which, together with the Company, provide the necessary warranty
work and/or normal service to customers.
The Company's warranty on its products is: for parts only, the earlier of one
year from the date of first use or 14 months from date of shipment; compressors
(if applicable), an additional four years; on gas-fired heat exchangers (if
applicable), 15 years; and on stainless steel heat exchangers (if applicable),
25 years.
Research and Development
All R&D activities of the Company are company-sponsored, rather than
customer-sponsored. R&D has involved the HB, RM, RN, RL, NJ, DT and MN (rooftop
units), LL (chillers), CB (condensing units), F1 (air handlers) and BL
(boilers), as well as component evaluation and refinement, development of
control systems and new product development. The Company incurred research and
development expenses of $1,974,000 in 2006, $1,681,000 in 2005 and $1,072,000 in
2004.
Backlog
The Company had a current backlog as of March 1, 2007, of $62,798,000, compared
to $48,597,000 at March 1, 2006. The current backlog consists of orders
considered by management to be firm and substantially all of which will be
filled by August 1, 2007; however, the orders are subject to cancellation by the
customers.
Working Capital Practices
Working capital practices in the industry center on inventories and accounts
receivable. The Company regularly reviews its working capital with a view to
maintaining the lowest level consistent with requirements of anticipated levels
of operation. The Company's greatest needs arise during the months of
July-November, the peak season for inventory (primarily purchased material) and
accounts receivable. The Company's working capital requirements are generally
met by cash flow from operations and a bank revolving credit facility, which
currently permits borrowings up to $15,150,000. The Company believes that it
will have sufficient funds available to meet its working capital needs for the
foreseeable future. The Company expects to renew its revolving credit agreement
in July 2007.
Seasonality
Sales of the Company's products are moderately seasonal with the peak period
being July-November of each year.
Competition
In the standardized market, the Company competes primarily with Trane Company, a
division of American Standard, Inc., Carrier Corporation, a subsidiary of United
Technologies Corporation, Lennox International, Inc., and York, a division of
Johnson Controls. All of these competitors are substantially larger and have
greater resources than the Company. In the custom market, the Company competes
with many larger and smaller manufacturers. The Company competes on the basis of
total value, quality, function, serviceability, efficiency, availability of
product, product line recognition and acceptability of sales outlet. However, in
new construction where the contractor is the purchasing decision maker, the
Company often is at a competitive disadvantage on sales of its products because
of the emphasis placed on initial cost; whereas, in the replacement market and
other owner-controlled purchases, the Company has a better chance of getting the
business since quality and long-term cost are generally taken into account.
-3-
Employees
As of March 1, 2007, the Company had 1,368 employees and 73 temporaries, none of
whom is represented by unions. Management considers its relations with its
employees to be good.
Patents, Trademarks, Licenses and Concessions
The Company does not consider any patents, trademarks, licenses or concessions
held by it to be material to its business operations, other than patents issued
regarding its heat recovery wheel option, blower, gas-fired heat exchanger and
evaporative condenser desuperheater.
Environmental Matters
Laws concerning the environment that affect or could affect the Company's
domestic operations include, among others, the Clean Water Act, the Clean Air
Act, the Resource Conservation and Recovery Act, the Occupational Safety and
Health Act, the National Environmental Policy Act, the Toxic Substances Control
Act, regulations promulgated under these Acts, and any other federal, state or
local laws or regulations governing environmental matters. The Company believes
that it presently complies with these laws and that future compliance will not
materially adversely affect the Company's earnings or competitive position.
Available Information
The Company's Internet website address is http://www.aaon.com. Its annual
reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K and amendments to those reports filed or furnished pursuant to Section 13(a)
or 15(d) of the Exchange Act of 1934 will be available through the Company's
Internet website as soon as reasonably practical after the Company
electronically files such material with, or furnishes it to, the SEC.
Item 1A. Risk Factors.
The following risks and uncertainties may affect the Company's performance and
results of operations.
Our business can be hurt by an economic downturn.
Our business is affected by a number of economic factors, including the level of
economic activity in the markets in which we operate. A decline in economic
activity in the United States could materially affect our financial condition
and results of operations. Sales in the commercial and industrial new
construction markets correlate closely to the number of new homes and buildings
that are built, which in turn is influenced by cyclical factors such as interest
rates, inflation, consumer spending habits, employment rates and other
macroeconomic factors over which we have no control. In the HVAC business, a
decline in economic activity as a result of these cyclical or other factors
typically results in a decline in new construction and replacement purchases,
which would result in a decrease in our sales volume and profitability.
We may be adversely affected by problems in the availability, or increases in
the prices, of raw materials and components.
Problems in the availability, or increases in the prices, of raw materials or
components could depress our sales or increase the costs of our products. We are
dependent upon components purchased from third parties, as well as raw materials
such as steel, copper and aluminum. We enter into cancelable contracts on terms
from six months to one year for raw materials and components at fixed prices.
However, if a key supplier is unable or unwilling to meet our supply
requirements, we could experience supply interruptions or cost increases, either
of which could have an adverse effect on our gross profit.
-4-
We may not be able to successfully develop and market new products.
Our future success will depend upon our continued investment in research and new
product development and our ability to continue to realize new technological
advances in the HVAC industry. Our inability to continue to successfully develop
and market new products or our inability to achieve technological advances on a
pace consistent with that of our competitors could lead to a material adverse
effect on our business and results of operations.
We may incur material costs as a result of warranty and product liability claims
that would negatively affect our profitability.
The development, manufacture, sale and use of our products involve a risk of
warranty and product liability claims. Our product liability insurance policies
have limits that, if exceeded, may result in material costs that would have an
adverse effect on our future profitability. In addition, warranty claims are not
covered by our product liability insurance and there may be types of product
liability claims that are also not covered by our product liability insurance.
We may not be able to compete favorably in the highly competitive HVAC business.
Competition in our various markets could cause us to reduce our prices or lose
market share, or could negatively affect our cash flow, which could have an
adverse effect on our future financial results. Substantially all of the markets
in which we participate are highly competitive. The most significant competitive
factors we face are product reliability, product performance, service and price,
with the relative importance of these factors varying among our product line.
Other factors that affect competition in the HVAC market include the development
and application of new technologies and an increasing emphasis on the
development of more efficient HVAC products. Moreover, new product introductions
are an important factor in the market categories in which our products compete.
Several of our competitors have greater financial and other resources than we
have, allowing them to invest in more extensive research and development. We may
not be able to compete successfully against current and future competition and
current and future competitive pressures faced by us may materially adversely
affect our business and results of operations.
The loss of Norman H. Asbjornson could impair the growth of our business.
Norman H. Asbjornson, the founder of AAON, Inc., has served as the President and
Chief Executive Officer of the Company from inception to date. He has provided
the leadership and vision for our growth. Although important responsibilities
and functions have been delegated to other highly experienced and capable
management personnel, our products are technologically advanced and well
positioned for sales into the future and we carry key man insurance on Mr.
Asbjornson, his death, disability or retirement, could impair the growth of our
business. We do not have an employment agreement with Mr. Asbjornson.
Our stockholder rights plan and some provisions in our bylaws and Nevada law
could delay or prevent a change in control.
Our stockholder rights plan and some provisions in our bylaws and Nevada law
could delay or prevent a change in control, which could adversely affect the
price of our common stock.
AAON's business is subject to the risks of interruptions by problems such as
computer viruses.
Despite our company's implementation of network security measures, its services
are vulnerable to computer viruses, break-ins and similar disruptions from
unauthorized tampering with its computer systems. Any such event could have a
material adverse affect on our business.
Exposure to environmental liabilities could adversely affect our results of
operations.
Our future profitability could be adversely affected by current or future
environmental laws. We are subject to extensive and changing federal, state and
local laws and regulations designed to protect the environment in the United
States and in other parts of the world. These laws and regulations could impose
liability for remediation costs and result in civil or criminal penalties in
case of non-compliance. Compliance with environmental laws increases our costs
of doing business. Because these laws are subject to frequent change, we are
unable to predict the future costs resulting from environmental compliance.
-5-
1B. Unresolved Staff Comments.
None.
Item 2. Properties.
The plant and office facilities in Tulsa, Oklahoma, consist of a 337,000 square
foot building (322,000 sq. ft. of manufacturing/warehouse space and 15,000 sq.
ft. of office space) located on a 12-acre tract of land at 2425 South Yukon
Avenue (the "original facility"), and a 563,000 square foot
manufacturing/warehouse building and a 22,000 square foot office building (the
"expansion facility") located on a 40-acre tract of land across the street from
the original facility (2440 South Yukon Avenue). Both plants are of sheet metal
construction.
The original facility's manufacturing area is in a heavy industrial type
building, with total coverage by bridge cranes, containing manufacturing
equipment designed for sheet metal fabrication and metal stamping. The
manufacturing equipment contained in the original facility consists primarily of
automated sheet metal fabrication equipment, supplemented by presses, press
breaks and NC punching equipment. Assembly lines consist of four cart-type
conveyor lines with variable line speed adjustment, three of which are motor
driven. Subassembly areas and production line manning are based upon line speed.
The manufacturing facility is 1,140 feet in length and varies in width from 390
feet to 220 feet.
The expansion facility is 39% (228,000 sq. ft.) utilized by the Company and 61%
leased to a third party. The Company uses 22,000 sq. ft. for office space,
20,000 sq. ft. for warehouse space and 80,000 sq. ft. for two production lines;
an additional 106,000 square feet is utilized for sheet metal fabrication. The
remaining 357,000 sq. ft. (presently leased) will afford the Company additional
plant space for long-term growth.
Production at these facilities averaged approximately $17.9 million per month in
2006, which is approximately 55% of the estimated current production capacity.
Management deems its facilities to be nearly ideal for the type of products
being manufactured by the Company.
The Company's operations in Longview, Texas, are conducted in a plant/office
building at 203-207 Gum Springs Road, containing 258,000 sq. ft. on 14 acres.
The manufacturing area (approximately 251,000 sq. ft.) is located in three
120-foot wide sheet metal buildings connected by an adjoining structure. The
facility is built for light industrial manufacturing. An additional, contiguous
15 acres were purchased in 2004 and 2005 for future expansion.
The Company's operations in Burlington, Ontario, Canada, are located at 279
Sumach Drive, consisting of an 82,000 sq. ft. office/manufacturing facility on a
5.6 acre tract of land.
Item 3. Legal Proceedings.
The Company is not a party to any pending legal proceeding which management
believes is likely to result in a material liability and no such action is
contemplated by or, to the best of its knowledge, has been threatened against
the Company.
Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted to a vote of security holders, through solicitation of
proxies or otherwise, during the period from October 1, 2006, through December
31, 2006.
-6-
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities.
The Company's Common Stock is traded on the NASDAQ Global Select Market under
the symbol "AAON". The range of closing prices for the Company's Common Stock
during the last two years, as reported by National Association of Securities
Dealers, Inc., was as follows:
Quarter Ended High Low
------------- ---- ---
March 31, 2005 $16.46 $13.91
June 30, 2005 $18.99 $16.15
September 30, 2005 $19.33 $16.28
December 31, 2005 $18.46 $16.22
March 31, 2006 $23.91 $18.10
June 30, 2006 $28.53 $20.96
September 30, 2006 $26.80 $21.41
December 31, 2006 $29.01 $21.48
On February 28, 2007, there were 998 holders of record, and 2,264 beneficial
owners, of the Company's Common Stock.
On February 14, 2006, the Board of Directors voted to initiate a semi-annual
cash dividend of $0.20 per share to the holders of the outstanding Common Stock
of the Company to be declared at dates of the Board's discretion. In 2006,
dividends were declared to shareholders of record at the close of business on
June 12, 2006 and paid on July 3, 2006 and declared to shareholders of record at
the close of business on December 11, 2006 and paid on January 3, 2007. The
Company paid cash dividends of $2,478,000 and declared dividends payable of
$2,465,000 for the year ended December 31, 2006.
Following repurchases of approximately 12% of its outstanding Common Stock
between September 1999 and September 2001, the Company announced and began its
current stock repurchase program on October 17, 2002, targeting repurchases of
up to an additional 10% (1,325,000 shares) of its outstanding stock. Through
December 31, 2005, the Company had repurchased a total of 1,257,864 shares under
the current program for an aggregate price of $22,034,568, or an average of
$17.52 per share. On February 14, 2006, the Board of Directors approved the
suspension of the Company's repurchase program.
On July 1, 2005, the Company entered into a stock repurchase arrangement by
which employee-participants in AAON's 401(k) savings and investment plan are
entitled to have shares of AAON stock in their accounts sold to the Company to
provide diversification of their investments. The maximum number of shares to be
repurchased is unknown under the program as the amount is contingent on the
number of shares sold by employees. Through December 31, 2006, the Company
repurchased 246,551 shares for an aggregate price of $5,185,000 or an average
price of $21.03 per share. The Company purchases the shares at the current
market price.
-7-
Repurchases during the fourth quarter of 2006 were as follows:
ISSUER PURCHASES OF EQUITY SECURITIES
- ------------------ ------------- ------------ ----------------- ---------------------
(d) Maximum
(c) Total Number Number (or
(a)Total (b) of Shares (or Approximate Dollar
Number of Average Units) Purchased Value) of Shares (or
Period Shares (or Price Paid as Part of Units) that May Yet
Units) Per Share Publicly Be Purchased Under
Purchased (or Unit) Announced Plans the Plans or
or Programs Programs
- ------------------ ------------- ------------ ----------------- ---------------------
Month #1
October 1-31, 6,867 $23.63 6,867 -
2006
- ------------------ ------------- ------------ ----------------- ---------------------
Month #2
November 1-30, 8,685 $25.87 8,685 -
2006
- ------------------ ------------- ------------ ----------------- ---------------------
Month #3
December 1-31, 19,145 $25.53 4,145 -
2006
- ------------------ ------------- ------------ ----------------- ---------------------
Total 34,697 $25.24 19,697 -
- ------------------ ------------- ------------ ----------------- ---------------------
Stock Performance Graph (1)
The following graph compares the cumulative total shareholder return of the
Company, the NASDAQ Composite and its peer group named below. The graph assumes
a $100 investment at the closing price on January 1, 2001, and reinvestment of
dividends on the date of payment without commissions. This table is not intended
to forecast future performance of the Company's common stock.
Comparison of 5 Year Cumulative Total Return
Among AAON, Inc., NASDAQ Composite and Peer Group*
2001 2002 2003 2004 2005 2006
---- ---- ---- ---- ---- ----
AAON INC Return % 12.98 5.31 -17.21 11.25 48.10
Cum $ 100.00 112.98 118.97 98.50 109.58 162.28
NASDAQ Composite Return % -31.24 50.79 9.16 2.12 10.39
- Total Returns Cum $ 100.00 68.76 103.68 113.18 115.57 127.58
Peer Group Return % 5.84 42.35 20.83 1.36 15.71
Cum $ 100.00 105.84 150.67 182.06 184.55 213.54
* The peer group consists of American Standard Companies, Fedders Corp., Lennox
International, Inc., Mestek, Inc., and LSB Industries, Inc., all of which are in
the business of manufacturing air conditioning and heat exchange equipment.
(1) SEC filings sometimes "incorporate information by reference." This
means the Company is referring you to information that has previously
been filed with the SEC, and that this information should be
considered as part of the filing you are reading. Unless the Company
specifically states otherwise, this Stock Performance Graph shall not
be deemed to be incorporated by reference and shall not constitute
soliciting material or otherwise be considered filed under the
Securities Act of 1933 as amended, or the Securities Exchange act of
1934, as amended.
-8-
Item 6. Selected Financial Data.
The following selected financial data should be read in conjunction with the
financial statements and related notes thereto for the periods indicated which
are included elsewhere in this report.
Year Ended December 31,
- ------------------------------------------------------------------------------------------------------------------
Results of Operations: 2006 2005 2004 2003 2002
---- ---- ---- ---- ----
(in thousands, except per share data)
Net sales $ 231,460 $ 185,195 $ 171,885 $ 147,890 $ 154,141
Net income $ 17,133 $ 11,462 $ 7,521 $ 14,227 $ 14,611
Cash dividends declared per
common share $ 0.40 $ - $ - $ - $ -
Basic earnings per share $ 1.39 $ .93 $ 0.60 $ 1.12 $ 1.11
Diluted earnings per share $ 1.35 $ .90 $ 0.58 $ 1.07 $ 1.06
Weighted average shares outstanding:
Basic 12,304 12,340 12,435 12,685 13,158
Diluted 12,652 12,750 12,923 13,251 13,740
December 31,
- ------------------------------------------------------------------------------------------------------------------
Financial Position at End of 2006 2005 2004 2003 2002
Fiscal Year: ---- ---- ---- ---- ----
Working capital $ 36,356 $ 33,372 $ 27,939 $ 35,369 $ 21,149
Total assets $ 130,056 $ 113,606 $ 105,227 $ 102,085 $ 91,713
Long-term and current debt $ 59 $ 167 $ 275 $ - $ -
Stockholders' equity $ 91,592 $ 79,495 $ 71,171 $ 67,428 $ 62,310
Basic earnings per common share were computed by dividing net income by the
weighted average number of shares of common stock outstanding during the
reporting period. Diluted earnings per common share were determined on the
assumed exercise of dilutive options, as determined by applying the treasury
stock method. Effective September 28, 2001 and June 4, 2002, the Company
completed three-for-two stock splits. The shares outstanding and earnings per
share disclosures have been restated to reflect the stock splits.
-9-
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Overview
AAON engineers, manufactures and markets air-conditioning and heating equipment
consisting of standardized and custom rooftop units, chillers, air-handling
units, make-up units, heat recovery units, condensing units, coils and boilers.
Custom units are marketed and sold to retail, manufacturing, educational,
medical and other commercial industries. AAON markets units to all 50 states in
the United States and certain provinces in Canada. International sales are less
than five percent as the majority of all sales are domestic.
AAON sells its products to property owners and contractors through a network of
manufacturers' representatives and its internal sales force. Demand for the
Company's products is influenced by national and regional economic and
demographic factors. The commercial and industrial new construction market is
subject to cyclical fluctuations in that it is generally tied to housing starts,
but has a lag factor of 6-18 months. Housing starts, in turn, are affected by
such factors as interest rates, the state of the economy, population growth and
the relative age of the population. When new construction is down, the Company
emphasizes the replacement market.
The principal components of cost of goods sold are labor, raw materials,
component costs, factory overhead, freight out and engineering expense. The
principal raw materials used in AAON's manufacturing processes are steel, copper
and aluminum. Prices increased by approximately 24% for steel, 42% for aluminum
and copper ranged from increases of 175%-400% from 2004 to 2006. The increases
resulted in economic challenges to AAON. AAON reviewed and adjusted current
pricing strategies, created efficiencies in production, and continued
relationships with suppliers in order to mitigate the economic factors of
increasing commodity prices. The major component costs include compressors,
electric motors and electronic controls, which also increased due to increases
in commodities.
Selling, general, and administrative ("SG&A") costs include the Company's
internal sales force, warranty costs, profit sharing and administrative expense.
Warranty expense is estimated based on historical trends and other factors. The
Company's warranty on its products is: for parts only, the earlier of one year
from the date of first use or 14 months from date of shipment; compressors (if
applicable), an additional four years; on gas-fired heat exchangers (if
applicable), 15 years; and on stainless steel heat exchangers (if applicable),
25 years. Warranty charges on heat exchangers do not occur frequently.
The office facilities of the Company consist of a 337,000 square foot building
(322,000 sq. ft. of manufacturing/warehouse space and 15,000 sq. ft. of office
space) located at 2425 S. Yukon Avenue, Tulsa, Oklahoma (the "original
facility"), and a 563,000 square foot manufacturing/warehouse building and a
22,000 square foot office building (the "expansion facility") located across the
street from the original facility at 2440 S. Yukon Avenue. The Company utilizes
39% of the expansion facility and the remaining 61% is leased to a third party.
Other operations are conducted in a plant/office building at 203-207 Gum Springs
Road in Longview, Texas, containing 258,000 square feet (251,000 sq. ft. of
manufacturing/warehouse and 7,000 sq. ft. of office space). An additional 15
acres of land was purchased for future expansion in 2004 and 2005 in Longview,
Texas. The Company's operations in Burlington, Ontario, Canada, are located at
279 Sumach Drive, consisting of an 82,000 sq. ft. office/manufacturing facility
on a 5.6 acre tract of land.
-10-
Set forth below is income statement information and as a percentage of sales
with respect to the Company for years 2006, 2005 and 2004:
Year Ended December 31,
2006 2005 2004
---- ---- ----
(in thousands)
Net sales $ 231,460 100.0% $ 185,195 100.0% $ 171,885 100.0%
Cost of sales 187,570 81.0% 149,904 81.0% 145,021 84.3%
--------------- ---------- --------------- ---------- --------------- ----------
Gross profit 43,890 19.0% 35,291 19.0% 26,864 15.7%
Selling, general and
administrative expenses 18,059 7.8% 17,477 9.4% 15,214 8.9%
--------------- ---------- --------------- ---------- --------------- ----------
Income from operations 25,831 11.2% 17,814 9.6% 11,650 6.8%
--------------- ---------- --------------- ---------- --------------- ----------
Interest expense (81) 0.0% (16) 0.0% (38) 0.0%
Interest income 24 0.0% 67 0.0% 183 0.1%
Other income, net 424 0.1% 467 0.3% 584 0.3%
--------------- ---------- --------------- ---------- --------------- ----------
Income before income taxes 26,198 11.3% 18,332 9.9% 12,379 7.2%
Income tax provision 9,065 3.9% 6,870 3.7% 4,858 2.8%
--------------- ---------- --------------- ---------- --------------- ----------
Net income $ 17,133 7.4% $ 11,462 6.2% $ 7,521 4.4%
=============== ========== =============== ========== =============== ==========
Results of Operations
Key events impacting AAON's cash balance, financial condition, and results of
operations in 2006 include the following:
o An increase in the volume of sales on all product lines due to
commercial construction growth and market share gains and effective
moderation of commodity costs with purchase agreements and pricing
strategies affecting gross margin positively resulted in significantly
higher revenues and net income. The large volume of sales also lowered
the effect of major fixed costs in general and administrative expenses
and occupancy expenses.
o AAON remained the leader in the industry for environmentally-friendly,
energy efficient and quality innovations, utilizing R410A refrigerant
and phasing out pollutant causing R22 refrigerant. The phase out of
R22 began at the beginning of 2004. AAON also utilizes a high
performance composite foam panel to eliminate over half of the heat
transfer from typical fiberglass insulated panels. AAON continues to
utilize sloped condenser coils, and access compartments to filters,
motor, and fans. All of these innovations increase the demand for
AAON's products thus increasing market share.
o In February 2006, the Board of Directors authorized a semi-annual cash
dividend payment. Cash payments of $ 2.5 million were made in 2006,
and $2.4 million accrued as a liability for payment in January of
2007.
o Stock repurchases of AAON stock from employee's 401(k) savings and
investments plan was authorized in 2005. AAON continued to repurchase
stock from employees throughout 2006, resulting in cash payments of
$3.9 million. This cash outlay is partially offset by cash received
from options exercised by employees as a part of an incentive bonus
program. The cash received in 2006 from options exercised was $1.3
million.
o Borrowings under the line of credit were approximately $53.7 million,
and $82 thousand in interest expense was paid in 2006. Borrowings
under the line of credit where interest is accrued are relatively
short and generally paid off within the month incurred or the
following month. At the end of 2006 there were no borrowings owed on
the line of credit.
o Purchases of equipment and renovations to manufacturing facilities
remained a priority. AAON capital expenditures were $17.8 million.
Equipment purchases create significant efficiencies, lower production
costs and allow continued growth in production. The Company currently
estimates to dedicate $10.0 million to capital expenditures in 2007
for continued growth.
-11-
Net Sales
Net sales were approximately $231.5 million, $185.2 million, and $171.9 million
in 2006, 2005 and 2004. The highest level of sales occurred in 2006. This
increase in sales of $46.3 million or 25.0% resulted from an increase in sales
volume from active marketing by sales representatives and pricing strategies in
order to keep up with increasing raw materials costs. New commercial
construction steadily improved throughout 2006 allowing widening of the market.
Management anticipates continued growth throughout 2007. The increase in sales
in 2005 of $13.3 million or 7.7% was attributable to both volume and price
increases. The increased sales were offset by computer and electrical outages
that caused the closing of the Tulsa facility for four days.
Gross Profit
Gross margins in 2006, 2005 and 2004 were $43.9 million, $35.3 million and $26.9
million, respectively. As a percentage of sales, gross margins were 19.0%, 19.0%
and 15.7% for the years ended 2006, 2005 and 2004. This stable gross profit
percentage from 2005 to 2006 results from adjusting pricing strategies for
continued high material costs for raw materials and components. Management
anticipates the moderation of commodity costs through relationships with
suppliers and price decreases in certain commodity costs will only enhance
already increased margins. Certain labor efficiencies were also experienced in
2006 adding to the positive gross margin. The lower gross margins from 2004
resulted from high material costs, and higher than normal repair expenses to
moderate sheet metal down time. Due to an increase in the volume of sales,
actual gross profit for 2006 increased by $8.6 million from 2005 and $8.4
million from 2004.
Steel, copper and aluminum are high volume materials used in the manufacturing
of the Company's products, which are obtained from domestic suppliers. Raw
materials prices increased approximately 24% for steel, 42% for aluminum and
copper increases ranged from 175% to 400% from 2004 to 2006, causing increased
inventory costs. The Company also purchases from other domestic manufacturers
certain components, including compressors, electric motors and electrical
controls used in its products. The suppliers of these components are
significantly affected by the rising raw material costs, as steel, copper and
aluminum are used in the manufacturing of their products; therefore the Company
is also experiencing price increases from component part suppliers. The Company
instituted several price increases from 2004 to 2006 to customers in an attempt
to offset the continued increases in steel, copper and aluminum. The Company
attempts to limit the impact of price increases on these materials by entering
into cancelable fixed price contracts with its major suppliers for periods of
6-12 months. In many instances, due to significant price increases in 2004,
suppliers refused to sell materials at the originally negotiated six-month or
one year purchase order price.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $18.1 million, $17.5 million
and $15.2 million for the years ended 2006, 2005 and 2004. The increase in
selling, general and administrative expenses was caused primarily by an increase
in sales expenditures for an increased sales force and active marketing, salary
increases in salaries for selling, general and administrative personnel were
approved in 2006 and increased net income caused an increase in profit sharing.
There were additional non-cash compensation costs for the fair value of stock
options granted to employees in accordance with the adoption of SFAS 123(R).
These increases were partially offset by a decrease of $1.9 million in warranty
expenses in the fourth quarter of 2006 based on changes in the estimated accrual
from actual warranty costs and occurrences due to quality improvements. In 2005
an increase of $2.3 million (15.1%) compared to 2004 occurred due primarily to
an increase in professional fees, computer consulting, internal accounting
expenses resulting from Sarbanes Oxley requirements, employee profit sharing and
a full year of expenses associated with the Canadian facility. The asset
acquisition for the Canadian facilities occurred May 4, 2004.
-12-
Interest Expense
Interest expense in 2006 was $81,000, $16,000 and $38,000 for the years ended
2006, 2005 and 2004. The increase in interest expense of $65,000 in 2006 was due
to an increase in average borrowings under the revolving credit facility and
increases in interest rates. Interest on borrowings is payable monthly at the
Wall Street Journal prime rate less 0.5% or LIBOR plus 1.6%, at the election of
the Company (6.95% at December 31, 2006). Average borrowings under the revolving
credit facility are typically paid in full within the month of borrowing or the
following month. The reduction in interest expense in 2005 from 2004 was due to
lower average borrowings under the credit facility.
Interest Income
Interest income was $24,000, $67,000 and $183,000 in 2006, 2005 and 2004
respectively. The decrease in interest income is due to lower balances in
certificates of deposit and short-term money markets.
Other Income
Other income was $424,000, $467,000 and $584,000 in 2006, 2005 and 2004,
respectively. Other income is attributable primarily to rental income from the
Company's expansion facility. All expenses associated with the facility that are
allocated to the rental portion of the building are included in other income.
The Company plans to continue to monetize the expansion facility until it is
needed for increased capacity.
Analysis of Liquidity and Capital Resources
AAON's working capital and capital expenditure requirements are generally met
through net cash provided by operations and the revolving bank line of credit.
Cash Flows Provided by Operating Activities. Net cash provided by operating
activities has fluctuated from year to year. Net cash provided by operating
activities was approximately $19.4 million, $12.0 million and $16.2 million in
fiscal years 2006, 2005 and 2004, respectively. The year-to-year variances are
primarily from results of changes in net income, accounts receivable,
inventories held by the Company, accounts payable and accrued liabilities.
Net income for fiscal year 2006 was approximately $17.1 million, an increase of
$5.7 million from fiscal year 2005, due primarily to increased volume of sales,
adjusted pricing strategies to compensate for higher raw materials costs,
innovative and efficient products, as well as strong economic growth of the
commercial construction industry. The increase in net income during fiscal year
2005 compared to fiscal year 2004 was also due to increased volume in sales and
adjusted pricing strategies.
Depreciation expense for December 31, 2006, 2005 and 2004 was $9.1 million, $8.5
million and $5.7 million, respectively. The continued increase is due to
increased capital expenditure purchases for growth and production efficiencies.
The Company adopted SFAS 123(R) in 2006, share-based compensation, which
decreased net income by $0.5 million. Share-based compensation was not
applicable in 2005 or 2004. Both depreciation expense and share-based
compensation expense decreased net income but had no effect on operating cash.
Accounts receivable balances have continued to increase in 2005 and 2006 from
the increase in sales. Accounts receivable increased by $4.3 million at December
31, 2006 compared to December 31, 2005. The increase at December 31, 2005 from
December 31, 2004 was $5.4 million.
Inventories increased by approximately $5.8 million, $2.8 million and $0.7
million at December 31, 2006, 2005 and 2004, respectively. The leading factor in
the increase is primarily related to the valuation of inventories since 2004 due
to higher raw material and component parts costs. The increase is also
attributable to procurement of inventory to accommodate an increase of sales.
The increase in 2005 from 2004 is related to increased sales and valuation of
inventory.
-13-
Prepaid expenses decreased by $0.8 million at December 31, 2006 compared to an
increase of $0.6 million at December 31, 2005. This decrease was primarily
related to prepaid copper inventory at 2005 pricing for 2006 material
requirements that was included in prepaid expenses at December 31, 2005.
Accounts payable and accrued liabilities increased by $4.3 million, $2.3 million
and $4.5 million at December 31, 2006, 2005 and 2004. The increase in 2006
related to commissions payable and timing of payments to vendors. The change
from December 31, 2005, compared to December 31, 2004, was also attributable to
timing of commissions payable and payments to vendors.
Cash Flows Used in Investing Activities. Cash flows used in investing activities
were $16.8 million, $8.2 million and $11.7 million in 2006, 2005 and 2004,
respectively. The increase in cash flows used in investing activities in 2006
were primarily related to capital expenditures of $17.8 million for additions of
machinery and equipment for increased efficiency and a manufacturing addition at
the Longview facility. Cash flows used in investing activities in 2005 consisted
primarily of capital expenditures of $10.1 million for additions of machinery
and equipment and an office renovation for the facility located in Longview.
Cash flows used in investing activities in 2004 related to capital expenditure
additions totaling $17.0 million, reflecting primarily additions to machinery
and equipment, a sheet metal facility at the Tulsa plant and renovations made to
the Company's Tulsa manufacturing and Longview office facilities. Management
properly utilizes cash flows provided from operating activities to fund capital
expenditures that are expected to spur growth and create efficiencies. Due to
anticipated production demands, the Company expects to expend approximately
$10.0 million in 2007 for equipment requirements. The Company expects the cash
requirements to be provided from cash flows from operations.
In 2006, the Company invested a total of $2 million in certificates of deposit,
the latest one maturing in July of 2006. In 2005, the Company invested $1
million in a certificate of deposit, which matured in the first quarter of 2006.
In 2002, the Company invested $10 million in a certificate of deposit that
matured in 2004 and an additional $3 million was invested in certificate of
deposits in 2004, which matured in the first quarter of 2005. In 2004,
additional funds were used to acquire certain Canadian assets and liabilities.
Cash Flows Used in Financing Activities. Cash flows used in financing activities
were $3.3 million, $4.2 million and $9.9 million in 2006, 2005 and 2004,
respectively. The increase of cash used in financing activities primarily
relates to cash dividends declared and paid and the continued repurchase of the
Company's stock.
The Company utilizes the revolving line of credit as described below in
'General' to meet certain short-term cash demands based on current liquidity at
the time. The Company accessed $53.7 million of borrowings under the line of
credit and paid each separate borrowing within the month the borrowing occurred
or the following month, resulting in no net borrowings under the revolving line
of credit at December 31, 2006. The Company utilized the revolving line of
credit in 2005 and 2004 for short-term cash demands in the amount of $21.1
million and $45.5 million, respectively. The Company had no net
borrowings/(repayments) in 2005, and had $(5.4) million in 2004
The Company received cash from stock options exercised of $1.3 million and
classified the tax benefit of stock options exercised of $1.9 million in
financing activities in 2006. The Company received cash from stock options
exercised for the years ended 2005 and 2004 of $820,000 and $478,000,
respectively.
In October 2002, the Company's Board of Directors authorized a stock buyback
program to repurchase up to 1,325,000 shares of stock. The Company repurchased
shares of stock under the authorized stock buyback programs in 2006, 2005 and
2004. The Company repurchased shares of stock from employees' 401(k) savings and
investment plan and other incentive plans in 2006 in the amount of $3.9 million
for 167,000 shares of stock. There were 182,900 shares of stock repurchased for
a total of $4.9 million and 265,100 shares of stock repurchased for a total of
$5.0 million in 2005 and 2004, respectively.
In February of 2006, the Board of Directors authorized a semi-annual cash
dividend payment. Cash dividend payments of $2.5 million were made in 2006, and
$2.4 million declared and accrued as a liability in December 2006 for payment in
January of 2007. Board approval is required to determine the date of declaration
for each semi-annual payment. Prior to 2006, no cash dividends had been declared
or paid.
-14-
General
The Company's revolving credit facility provides for maximum borrowings of $15.2
million which is provided by the Bank of Oklahoma, National Association. Under
the line of credit, there is one standby letter of credit totaling approximately
$600,000. The letter of credit is a requirement of the Company's workers
compensation insurance and was extended in 2006 and will expire on December 31,
2007. Interest on borrowings is payable monthly at the Wall Street Journal prime
rate less 0.5% or LIBOR plus 1.6%, at the election of the Company (6.95% at
December 31, 2006). No fees are associated with the unused portion of the
committed amount. At December 31, 2006 and December 31, 2005, the Company had no
borrowings outstanding under the revolving credit facility. Borrowings available
under the revolving credit facility at December 31, 2006, were $14.6 million.
The credit facility previously required the Company to maintain a certain
financial ratio and prohibited the declaration of cash dividends. On February
14, 2006, the Board of Directors voted to initiate a semi-annual cash dividend
of $0.20 per share to the holders of the outstanding Common Stock. In
conjunction with the Board's vote on February 14, 2006, the restriction of
payments of dividends was waived by the lender and removed from the covenants
with the renewal of the line of credit on July 30, 2006. At December 31, 2006,
the Company was in compliance with its financial ratio covenants. On July 30,
2006, the Company renewed the line of credit with a maturity date of July 30,
2007.
Management believes the Company's bank revolving credit facility (or comparable
financing), and projected cash flows from operations will provide the necessary
liquidity and capital resources to the Company for fiscal year 2007 and the
foreseeable future. The Company's belief that it will have the necessary
liquidity and capital resources is based upon its knowledge of the HVAC industry
and its place in that industry, its ability to limit the growth of its business
if necessary, its ability to authorize dividend cash payments, and its
relationship with its existing bank lender. For information concerning the
Company's revolving credit facility at December 31, 2006, see Note 4 to the
financial statements included in this report.
Commitments and Contractual Agreements
The Company is a party to several short-term, cancelable, fixed price contracts
with major suppliers for the purchase of raw material and component parts.
The Company has cancelable commitments to purchase machinery and equipment at a
cost of $4.8 million.
The following table summarizes the Company's long-term debt and other
contractual agreements as of December 31, 2006:
Payments Due By Period
(in thousands)
Less Than 1 1-3 4-5 After 5
Total Year Years Years years
--------------- --------------- ----------- ----------- -------------
Long-term debt and capital leases $ 59 $ 59 $ - $ - $ -
Estimated interest payments on fixed
rate long-term debt and capital leases 1 1 - - -
Operating lease obligations 5 5 - - -
Purchase commitments $ 4,776 $ 4,776 - - -
--------------- --------------- ----------- ----------- -------------
Total contractual obligations $ 4,841 $ 4,841 $ - $ - $ -
=============== =============== =========== =========== =============
The fixed rate interest on long-term debt includes the amount of interest due on
the Company's fixed rate long-term debt. These amounts do not include interest
on the Company's variable rate obligation related to the Company's revolving
credit facility.
-15-
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Because these estimates and assumptions require significant
judgment, future actual results could differ from those estimates and could have
a significant impact on the Company's results of operations, financial position
and cash flows. The Company reevaluates its estimates and assumptions on a
monthly basis.
The following accounting policies may involve a higher degree of estimation or
assumption:
Allowance for Doubtful Accounts - The Company establishes an allowance for
doubtful accounts based upon factors surrounding the credit risk of specific
customers, historical trends in collections and write-offs, current customer
status, the age of the receivable, economic conditions and other information.
Aged receivables are reviewed on a monthly basis to determine if the reserve is
adequate and adjusted accordingly at that time. The evaluation of these factors
involves complex, subjective judgments. Thus, changes in these factors or
changes in economic circumstances may significantly impact the consolidated
financial statements.
Inventory Reserves - The Company establishes a reserve for inventories based on
the change in inventory requirements due to product line changes, the
feasibility of using obsolete parts for upgraded part substitutions, the
required parts needed for part supply sales, replacement parts and for estimated
shrinkage.
Warranty - A provision is made for estimated warranty costs at the time the
product is shipped and revenue is recognized. The warranty period is: for parts
only, the earlier of one year from the date of first use or 14 months from date
of shipment; compressors (if applicable), an additional four years; on gas-fired
heat exchangers (if applicable), 15 years; and on stainless steel heat
exchangers (if applicable), 25 years. Warranty expense is estimated based on the
Company's warranty period, historical warranty trends and associated costs, and
any known identifiable warranty issue. Warranty charges associated with heat
exchanges do not occur frequently.
Due to the absence of warranty history on new products, an additional provision
may be made for such products. The Company's estimated future warranty cost is
subject to adjustment from time to time depending on changes in actual warranty
trends and cost experience. Should actual claim rates differ from the Company's
estimates, revisions to the estimated product warranty liability would be
required.
Medical Insurance - A provision is made for medical costs associated with the
Company's Medical Employee Benefit Plan, which is primarily a self-funded plan.
A provision is made for estimated medical costs based on historical claims paid
and any known potential of significant future claims. The plan is supplemented
by employee contributions and an excess policy for claims over $100,000 each.
Historically, actual results have been within management's expectations.
Stock Compensation - The Company adopted Statement of Financial Accounting
Standard ("SFAS") No. 123(R), Share-Based Payment, effective January 1, 2006.
Applying this standard to value equity-based compensation requires the Company
to use significant judgment and to make estimates, particularly for the
assumptions used in the Black-Scholes valuation model, such as stock price
volatility and expected option lives, as well as for the expected option
forfeiture rates. In accordance with the Statement the Company measures the cost
of employee services received in exchange for an award of equity instruments
using the Black-Scholes valuation model to calculate the grant-date fair value
of the award. The compensation cost is recognized over the period of time during
which an employee is required to provide service in exchange for the award,
which will be the vesting period.
-16
New Accounting Pronouncements
In November 2004, the Financial Accounting Standards Board ("FASB") released
SFAS No.151, Inventory Costs, an amendment of Accounting Research Bulletin No.
43, Chapter 4, Inventory Pricing. The Statement requires that abnormal amounts
of idle facility expense, freight, handling costs and spoilage should be
expensed as incurred and not included in overhead as an inventory cost. The new
Statement also requires that allocation of fixed production overhead costs
should be based on normal capacity of the production facilities. The Company
adopted this Statement on January 1, 2006. The adoption of this Statement did
not have a material impact on the Company's Consolidated Financial Statements.
In June 2005, the FASB issued SFAS 154, Accounting Changes and Error
Corrections, a replacement of Accounting Principles Board ("APB") Opinion No.
20, Accounting Changes, and FAS Statement No. 3, Reporting Accounting Changes in
Interim Financial Statements. SFAS 154 changes the requirements for the
accounting for and reporting of a change in accounting principle. Previously,
most voluntary changes in accounting principles were required to be recognized
via a cumulative effect adjustment within net income of the period of the
change. SFAS 154 requires retrospective application to prior periods' financial
statements, unless if it is impracticable to determine either the
period-specific effects or the cumulative effect of the change. SFAS 154 is
effective for accounting changes made in fiscal years beginning after December
15, 2005; however, SFAS 154 does not change the transition provisions of any
existing accounting pronouncements. The adoption of this Statement did not have
a material impact on the Company's Consolidated Financial Statements for the
year ended 2006.
In July 2006, the FASB released Financial Interpretation ("FIN") No. 48,
Accounting for Uncertainty in Income Taxes, an Interpretation of SFAS No. 109.
FIN 48 clarifies the accounting for uncertain tax positions as described in SFAS
No. 109, Accounting for Income Taxes, and requires a company to recognize, in
its financial statements, the impact of a tax position only if that position is
"more likely than not" of being sustained on an audit basis solely on the
technical merits of the position. FIN 48 also requires qualitative and
quantitative disclosures including a discussion of reasonably possible changes
that might occur in the recognized tax benefits over the next twelve months as
well as a roll-forward of all unrecognized tax benefits. FIN 48 is effective for
fiscal years beginning after December 15, 2006. Management is in the process of
determining the effect FIN 48 will have on the Company's Consolidated Financial
Statements and presently does not believe the adoption will have a material
effect on the Company's Consolidated Financial Statements.
In September 2006, the FASB released SFAS No. 157, Fair Value Measurements. SFAS
157 defines fair value and establishes a framework for measuring fair value in
generally accepted accounting principles, and expands disclosures about fair
value measurements. Although SFAS 157 applies to (and amends) the provisions of
existing authoritative literature, it does not, of itself, require any new fair
value measurements or establish valuation standards. SFAS 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. Adoption of SFAS 157 is not
expected to have a material impact on the Company's Consolidated Financial
Statements.
In September 2006, the staff of the Securities and Exchange Commission issued
Staff Accounting Bulletin ("SAB") No. 108, Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial
Statements. SAB 108 provides interpretive guidance on the consideration of the
effects of prior year misstatements in quantifying current year misstatements
for the purpose of a materiality assessment. The Company adopted SAB 108 for the
year ended December 31, 2006. The adoption did not have a material impact on the
Company's Consolidated Financial Statements as of December 31, 2006.
In February, 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities, which creates an alternative
measurement treatment for certain financial assets and financial liabilities.
SFAS 159 permits fair value to be used for both the initial and subsequent
measurements on an instrument by instrument basis, with changes in the fair
value to be recognized in earnings as those changes occur. This election is
referred to as the fair value option. SFAS 159 also requires additional
disclosures to compensate for the lack of comparability that will arise from the
use of the fair value option. SFAS 159 is effective for fiscal years beginning
after November 15, 2007. Adoption of SFAS 159 is not expected to have a material
impact on the Company's Consolidated Financial Statements.
-17-
In 2005, the FASB released SFAS 123(R), Share-Based Payment, which replaces
SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB
Opinion No. 25, Accounting for Stock Issued to Employees. The Statement requires
measurement of the cost of employee services received in exchange for an award
of equity instruments based on the grant-date fair value of the award. The
compensation cost will be recognized over the period of time during which an
employee is required to provide service in exchange for the award, which will be
the vesting period. The Statement applies to all awards granted and any unvested
awards at December 31, 2005. Effective January 1, 2006, the Company adopted the
fair value recognition method of SFAS No. 123(R) Share-Based Payment (SFAS
123R), using the modified-prospective-transition method. The Company incurred
$500,000 in non-cash expenditures for the year ended December 31, 2006 due to
the adoption of SFAS 123(R).
Forward-Looking Statements
This Annual Report includes "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. Words such as "expects",
"anticipates", "intends", "plans", "believes", "seeks", "estimates", "will", and
variations of such words and similar expressions are intended to identify such
forward-looking statements. These statements are not guarantees of future
performance and involve certain risks, uncertainties and assumptions, which are
difficult to predict. Therefore, actual outcomes and results may differ
materially from what is expressed or forecasted in such forward-looking
statements. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date on which they are
made. The Company undertakes no obligations to update publicly any
forward-looking statements, whether as a result of new information, future
events or otherwise. Important factors that could cause results to differ
materially from those in the forward-looking statements include (1) the timing
and extent of changes in raw material and component prices, (2) the effects of
fluctuations in the commercial/industrial new construction market, (3) the
timing and extent of changes in interest rates, as well as other competitive
factors during the year, and (4) general economic, market or business
conditions.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Company is subject to interest rate risk on its revolving credit facility,
which bears variable interest based upon a prime or LIBOR rate. The Company had
no outstanding balance as of December 31, 2006.
Foreign sales accounted for less than approximately 5% of the Company's sales in
2006 and the Company accepts payment for such sales in U.S. and Canadian
dollars; therefore, the Company believes it is not exposed to significant
foreign currency exchange rate risk on these sales. Foreign currency
transactions and financial statements are translated in accordance with SFAS No.
52, Foreign Currency Translation. The Company uses the U.S. dollar as its
functional currency, except for the Company's Canadian subsidiaries, which use
the Canadian dollar. Adjustments arising from translation of the Canadian
subsidiaries' financial statements are reflected in accumulated other
comprehensive income. Transaction gains or losses that arise from exchange rate
fluctuations applicable to transactions denominated in Canadian currency are
included in the results of operations as incurred. The exchange rate of the
United States dollar to the Canadian dollar was $0.859 and $0.862 at December
31, 2005 and December 31, 2006.
Important raw materials purchased by the Company are steel, copper and aluminum,
which are subject to price fluctuations. The Company attempts to limit the
impact of price increases on these materials by entering cancelable fixed price
contracts with its major suppliers for periods of 6 -12 months. However, from
2004 to 2006 cost increases in basic commodities, such as steel and aluminum,
rose by 24% and 42%, copper increases ranged from 175% to 400%, and impacted
profit margins.
The Company does not utilize derivative financial instruments to hedge its
interest rate, foreign currency exchange rate or raw materials price risks.
-18-
Item 8. Financial Statements and Supplementary Data.
The financial statements and supplementary data are included commencing at page
29.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
Item 9A. Controls and Procedures.
(a) Evaluation of Disclosure Controls and Procedures
At the end of the period covered by this Annual Report on Form 10-K, the
Company's management, under the supervision and with the participation of the
Company's Chief Executive Officer and Chief Financial Officer, has evaluated the
effectiveness of the design and operation of the Company's disclosure controls
and procedures. Based on that evaluation, the Company's Chief Executive Officer
and Chief Financial Officer believe that:
o The Company's disclosure controls and procedures are designed to
ensure that information required to be disclosed by the Company in the
reports it files under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms; and
o The Company's disclosure controls and procedures operate such that
important information flows to appropriate collection and disclosure
points in a timely manner and are effective to ensure that such
information is accumulated and communicated to the Company's
management, and made known to the Company's Chief Executive Officer
and Chief Financial Officer, particularly during the period when this
Annual Report was prepared, as appropriate to allow timely decisions
regarding the required disclosure.
AAON's Chief Executive Officer and Chief Financial Officer have evaluated the
Company's disclosure controls and procedures and concluded that these controls
and procedures were effective as of December 31, 2006.
(b) Management's Annual Report on Internal Control over Financial
Reporting
The management of AAON, Inc. and its subsidiaries (AAON), is responsible for
establishing and maintaining adequate internal control over financial reporting.
AAON's internal control system was designed to provide reasonable assurance to
the Company's management and Board of Directors regarding the preparation and
fair presentation of published financial statements.
All internal control systems, no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation.
In making its assessment of internal control over financial reporting,
management used the criteria issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO) in Internal Control--Integrated Framework.
Based on our assessment, we believe that, as of December 31, 2006, the Company's
internal control over financial reporting is effective based on those criteria.
-19-
AAON's independent registered public accounting firm has issued an attestation
report on management's assessment of the Company's internal control over
financial reporting.
Date: March 13, 2007 /s/ Norman H. Asbjornson
Norman H. Asbjornson
---------------------------
Chief Executive Officer
/s/ Kathy I. Sheffield
---------------------------
Kathy I. Sheffield
Chief Financial Officer
(c) Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm
-------------------------------------------------------
Board of Directors and
Stockholders of AAON, Inc.
We have audited management's assessment, included in the accompanying
Management's Annual Report on Internal Control Over Financial Reporting
(management's assessment), that AAON, Inc. (a Nevada corporation) and
subsidiaries (collectively, the Company) maintained effective internal control
over financial reporting as of December 31, 2006, based on criteria established
in Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Company's management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the Company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
-20-
In our opinion, management's assessment that AAON, Inc. maintained effective
internal control over financial reporting as of December 31, 2006, is fairly
stated, in all material respects, based on criteria established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Also, in our opinion, AAON,
Inc. maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2006, based on criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
AAON, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related
consolidated statements of income, stockholders' equity and comprehensive
income, and cash flows for each of the three years in the period ended December
31, 2006 and our report dated March 12, 2007 expressed an unqualified opinion on
those consolidated financial statements.
/s/ GRANT THORNTON LLP
Tulsa, Oklahoma
March 12, 2007
(d) Changes in Internal Control over Financial Reporting
There have been no changes in internal control over financial reporting that
occurred during the fourth quarter of 2006 that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
Item 9B. Other Information.
None.
-21-
PART III
Item 10. Directors, Executive Officers and Corporate Governance.
The information required by Items 401, 405, 406 and 407(c)(3), (d)(4) and (d)(5)
of Regulation S-K is incorporated by reference to the information contained in
the Company's definitive Proxy Statement to be filed with the Securities and
Exchange Commission in connection with the Company's 2007 Annual Meeting of
Stockholders.
Item 11. Executive Compensation.
The information required by Items 402 and 407(e)(4) and (e)(5) of Regulation S-K
is incorporated by reference to the information contained in the Company's
definitive Proxy Statement to be filed with the Securities and Exchange
Commission in connection with the Company's 2007 Annual Meeting of Stockholders.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
The information required by Item 403 and Item 201(d) of Regulation S-K is
incorporated by reference to the information contained in the Company's
definitive Proxy Statement to be filed with the Securities and Exchange
Commission in connection with the Company's 2007 Annual Meeting of Stockholders.
Item 13. Certain Relationships and Related Transactions.
Transactions with Related Persons
In 2006, the Company did not enter into any new related party transactions and
has no preexisting related party transactions.
AAON's Code of Conduct guides the Board of Directors in its actions and
deliberations with respect to related party transactions. Under the Code,
conflicts of interest, including any involving the directors or any Named
Officers, are prohibited except under any guidelines approved by the Board of
Directors. Only the Board of Directors may waive a provision of the Code of
Conduct for a director or a Named Officer, and only then in compliance with all
applicable laws and rules and regulations. In 2006, the Company did not enter
into any new related party transactions and has no preexisting related party
transactions.
Director Independence
The Board has adopted director independence standards that meets and/or exceed
listing standards set by NASDAQ. NASDAQ has set forth six applicable tests and
requires that a director who fails any of the tests be deemed not independent.
In 2006, the Board affirmatively determined that Messrs. Naugle, Pantaleoni,
Ryan, Short and Stephenson are independent. As an employee, Mr. Asbjornson is
not independent, and because he is a member of the law firm that serves as
General Counsel to the Company, the Board has determined that Mr. Johnson should
not be deemed independent. In addition, each member of the Audit Committee and
the Compensation Committee is independent.
The Company's director independence standards are as follows:
It is the policy of the Board of Directors that a majority of the members of the
Board consist of directors independent of the Company and of the Company's
management. For a director to be deemed "independent," the Board shall
affirmatively determine that the director has no material relationship with the
Company or its affiliates or any member of the senior management of the Company
or his or her affiliates. In making this determination, the Board applies, at a
minimum and in addition to any other standards for independence established
under applicable statutes and regulations as outlined by the NASDAQ listing
standards, the following standards, which it may amend or supplement from time
to time:
-22-
o A director who is, or has been within the last three years, an employee of
the Company, or whose immediate family member is, or has been within the
last three years a Named Officer, of the Company can not be deemed
independent. Employment as an interim Chairman or Chief Executive Officer
will not disqualify a director from being considered independent following
that employment.
o A director who has received, or who has an immediate family member who has
received, during any twelve-month period within the last three years, more
than $60,000 in direct compensation from the Company, other than director
and committee fees and benefits under a tax-qualified retirement plan, or
non-discretionary compensation for prior service (provided such
compensation is not contingent in any way on continued service), can not be
deemed independent. Compensation received by a director for former service
as an interim Chairman or Chief Executive Officer and compensation received
by an immediate family member for service as a non-executive employee of
the Company will not be considered in determining independence under this
test.
o A director who (A) is, or whose immediate family member is, a current
partner of a firm that is the Company's external auditor; (B) is a current
employee of such a firm; or (C) was, or whose immediate family member was,
within the last three years (but is no longer) a partner or employee of
such a firm and personally worked on the Company's audit within that time
can not be deemed independent.
o A director who is, or whose immediate family member is, or has been within
the last three years, employed as an executive officer of another company
where any of the Company's present Named Officers at the time serves or
served on that company's compensation committee can not be deemed
independent.
o A director who is a current employee or general partner, or whose immediate
family member is a current executive officer or general partner, of an
entity that has made payments to, or received payments from, the Company
for property or services in an amount which, in any of the last three
fiscal years, exceeds the greater of $200,000 or 5% of such other entity's
consolidated gross revenues, other than payments arising solely from
investments in the Company's securities or payments under non-discretionary
charitable contribution matching programs, can not be deemed independent.
For purposes of the independence standards set forth above, the terms:
o "affiliate" means any consolidated subsidiary of the Company and any
other Company or entity that controls, is controlled by or is under
common control with the Company;
o "executive officer" means an "officer" within the meaning of Rule
16a-1(f) under the Securities Exchange Act of 1934, as amended; and
o "immediate family" means spouse, parents, children, siblings, mothers-
and fathers-in-law, sons- and daughters-in-law, brothers- and
sisters-in-law and anyone (other than employees) sharing a person's
home, but excluding any person who is no longer an immediate family
member as a result of legal separation or divorce, death or
incapacitation.
The Board undertakes an annual review of the independence of all non-employee
directors. In advance of the meeting at which this review occurs, each
non-employee director is asked to provide the Board with full information
regarding the director's business and other relationships with the Company and
its affiliates and with senior management and their affiliates to enable the
Board to evaluate the director's independence.
Directors have an affirmative obligation to inform the Board of any material
changes in their circumstances or relationships that may impact their
designation by the Board as "independent." This obligation includes all business
relationships between, on the one hand, Directors or members of their immediate
family, and, on the other hand, the Company and its affiliates or members of
senior management and their affiliates, whether or not such business
relationships are subject to any other approval requirements of the Company.
Item 14. Principal Accountant Fees and Services.
The information required by Item 9(e) of Schedule 14A is incorporated by
reference to the Company's definitive Proxy Statement to be filed with the
Securities and Exchange Commission in connection with the Company's 2007 Annual
Meeting of Stockholders.
-23-
PART IV
Item 15. Exhibits and Financial Statement Schedules.
(a) Financial statements.
See Index to Consolidated Financial Statements on page 27.
(b) Exhibits:
(3) (A) Articles of Incorporation (i)
(A-1) Article Amendments (ii)
(B) Bylaws (i)
(B-1) Amendments of Bylaws (iii)
(4) (A) Third Restated Revolving Credit and Term Loan
Agreement and related documents (iv)
(A-1) Latest Amendment of Loan Agreement (v)
(B) Rights Agreement dated February 19, 1999, as
amended (vi)
(10) AAON, Inc. 1992 Stock Option Plan, as amended (vii)
(21) List of Subsidiaries (viii)
(23) Consent of Grant Thornton LLP
(31.1) Certification of CEO
(31.2) Certification of CFO
(32.1) Section 1350 Certification - CEO
(32.2) Section 1350 Certification - CFO
----------
(i) Incorporated herein by reference to the exhibits to the Company's
Form S-18 Registration Statement No. 33-18336-LA.
(ii) Incorporated herein by reference to the exhibits to the Company's
Annual Report on Form 10-K for the fiscal year ended December 31,
1990, and to the Company's Forms 8-K dated March 21, 1994, March
10, 1997, and March 17, 2000.
(iii) Incorporated herein by reference to the Company's Forms 8-K
dated March 10, 1997, May 27, 1998 and February 25, 1999, or
exhibits thereto.
(iv) Incorporated by reference to exhibit to the Company's Form 8-K
dated July 30, 2004.
(v) Incorporated herein by reference to exhibit to the Company's Form
8-K dated August 25, 2006
(vi) Incorporated by reference to exhibits to the Company's Forms 8-K
dated February 25, 1999, and August 20, 2002, and Form 8-A
Registration Statement No. 000-18953, as amended.
-24-
(vii) Incorporated herein by reference to exhibits to the Company's
Annual Report on Form 10-K for the fiscal year ended December 31,
1991, and to the Company's Form S-8 Registration Statement No.
33-78520, as amended.
(viii) Incorporated herein by reference to exhibits to the Company's
Annual Report on Form 10-K for the fiscal year ended December 31,
2004.
-25-
SIGNATURES
Pursuant to the requirement of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, hereunto duly authorized.
AAON, INC.
Dated: March 13, 2007 By: /s/ Norman H. Asbjornson
----------------------------------------
Norman H. Asbjornson, President
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Dated: March 13, 2007 /s/ Norman H. Asbjornson
---------------------------------------
Norman H. Asbjornson
President and Director
(principal executive officer)
Dated: March 13, 2007 /s/ Kathy I. Sheffield
---------------------------------------
Kathy I. Sheffield
Treasurer
(principal financial officer
and principal accounting officer)
Dated: March 13, 2007 /s/ John B. Johnson, Jr.
---------------------------------------
John B. Johnson, Jr.
Director
Dated: March 13, 2007 /s/ Thomas E. Naugle
---------------------------------------
Thomas E. Naugle
Director
Dated: March 13, 2007 /s/ Anthony Pantaleoni
---------------------------------------
Anthony Pantaleoni
Director
Dated: March 13, 2007 /s/ Jerry E. Ryan
---------------------------------------
Jerry E. Ryan
Director
Dated: March 13, 2007 /s/ Jack E. Short
---------------------------------------
Jack E. Short
Director
Dated: March 13, 2007 /s/ Charles C. Stephenson, Jr.
---------------------------------------
Charles C. Stephenson, Jr.
Director
-26-
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Registered Public Accounting Firm
- Grant Thornton LLP 28
Consolidated Balance Sheets 29
Consolidated Statements of Income 30
Consolidated Statements of Stockholders' Equity and Comprehensive Income 31
Consolidated Statements of Cash Flows 32
Notes to Consolidated Financial Statements 33
-27-
Report of Independent Registered Public Accounting Firm
-------------------------------------------------------
Board of Directors and
Stockholders of AAON, Inc.
We have audited the accompanying consolidated balance sheets of AAON, Inc. (a
Nevada Corporation) and subsidiaries (collectively, the Company) as of December
31, 2006 and 2005, and the related consolidated statements of income,
stockholders' equity and comprehensive income, and cash flows for each of the
three years in the period ended December 31, 2006. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of AAON, Inc. and
subsidiaries as of December 31, 2006 and 2005, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2006 in conformity with accounting principles generally accepted in
the United States of America.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of AAON, Inc.'s
internal control over financial reporting as of December 31, 2006, based on
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our
report dated March 12, 2007 expressed unqualified opinions on the effectiveness
of internal control over financial reporting and management's evaluation
thereof.
/s/ GRANT THORNTON LLP
Tulsa, Oklahoma
March 12, 2007
-28-
AAON, Inc., and Subsidiaries
Consolidated Balance Sheets
December 31,
2006 2005
-------------------------------------
(in thousands, except for share data)
Assets
Current assets:
Cash and cash equivalents $ 288 $ 837
Certificate of deposit - 1,000
Accounts receivable, net 36,748 32,487
Inventories, net 29,502 23,708
Prepaid expenses and other 267 1,041
Deferred tax asset 3,954 3,877
------------------ ------------------
Total current assets 70,759 62,950
Property, plant and equipment, net 59,222 50,581
Note receivable, long term 75 75
------------------ ------------------
Total assets $ 130,056 $ 113,606
================== ==================
Liabilities and Stockholders' Equity
Current liabilities:
Current maturities of long-term debt 59 108
Accounts payable 15,821 11,643
Dividends payable 2,465 -
Accrued liabilities 16,058 17,827
------------------ ------------------
Total current liabilities 34,403 29,578
Long-term debt, less current maturities - 59
Deferred tax liability 4,061 4,474
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value, 5,000,000 shares
authorized, no shares issued - -
Common stock, $.004 par value, 50,000,000 shares
authorized, 12,338,832 and 12,233,558 issued and
outstanding at December 31, 2006 and 2005, respectively 49 49
Additional paid in capital 210 -
Accumulated other comprehensive income 667 513
Retained earnings 90,666 78,933
------------------ ------------------
Total stockholders' equity 91,592 79,495
------------------ ------------------
Total liabilities and stockholders' equity $ 130,056 $ 113,606
================== ==================
The accompanying notes are an integral part of these statements.
-29-
AAON, Inc., and Subsidiaries
Consolidated Statements of Income
Year Ending December 31,
2006 2005 2004
-----------------------------------------------
(in thousands, except per share data)
Net sales $ 231,460 $ 185,195 $ 171,885
Cost of sales 187,570 149,904 145,021
-----------------------------------------------
Gross profit 43,890 35,291 26,864
Selling, general and administrative expenses 18,059 17,477 15,214
-----------------------------------------------
Income from operations 25,831 17,814 11,650
Interest expense (81) (16) (38)
Interest income 24 67 183
Other income, net 424 467 584
-----------------------------------------------
Income before income taxes 26,198 18,332 12,379
Income tax provision 9,065 6,870 4,858
-----------------------------------------------
Net income $ 17,133 $ 11,462 $ 7,521
===============================================
Earnings per share:
Basic $ 1.39 $ 0.93 $ 0.60
===============================================
Diluted $ 1.35 $ 0.90 $ 0.58
===============================================
Weighted average shares outstanding:
Basic 12,304 12,340 12,435
===============================================
Diluted 12,652 12,750 12,923
===============================================
The accompanying notes are an integral part of these statements.
-30-
AAON, Inc., and Subsidiaries
Consolidated Statements of Stockholders' Equity and Comprehensive Income
Accumulated
Other
Common Stock Paid-in Comprehensive Retained
Shares Amount Capital Income Earnings Total
-------------------------------------------------------------------------------------------
(in thousands)
Balance at December 31, 2003 12,520 $ 50 $ - $ - $ 67,378 $ 67,428
Comprehensive income:
Net income - - - - 7,521 7,521
Foreign currency translation
adjustment - - - 247 - 247
------------
Total comprehensive income 7,768
Stock options exercised, including tax
benefits 95 - 954 - - 954
Stock repurchased and retired (265) (1) (954) - (4,024) (4,979)
-------------------------------------------------------------------------------------------
Balance at December 31, 2004 12,350 49 - 247 70,875 71,171
Comprehensive income:
Net income - - - - 11,462 11,462
Foreign currency translation
adjustment - - - 266 - 266
------------
Total comprehensive income 11,728
Stock options exercised, including tax
benefits 162 1 1,507 - - 1,508
Stock repurchased and retired (278) (1) (1,507) - (3,404) (4,912)
-------------------------------------------------------------------------------------------
Balance at December 31, 2005 12,234 49 - 513 78,933 79,495
Comprehensive income:
Net income - - - - 17,133 17,133
Foreign currency translation
adjustment - - - 154 - 154
------------
Total comprehensive income 17,287
Stock options exercised, including tax
benefits 272 - 3,108 - - 3,108
Share-based compensation - - 500 - - 500
Stock repurchased and retired (167) - (3,398) - (457) (3,855)
Dividends declared - - - - (4,943) (4,943)
-------------------------------------------------------------------------------------------
Balance at December 31, 2006 12,339 $ 49 $ 210 $ 667 $ 90,666 $ 91,592
===========================================================================================
The accompanying notes are an integral part of these statements.
-31-
AAON, Inc., and Subsidiaries
Consolidated Statements of Cash Flows
Year Ended December 31,
2006 2005 2004
------------------------------------------
(in thousands)
Operating Activities
Net income $ 17,133 $ 11,462 $ 7,521
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 9,146 8,503 5,732
Provision for losses on accounts receivable (61) 68 521
Share-based compensation 500 - -
Excess tax benefits from stock options exercised (1,852) - -
(Gain)/Loss on disposition of assets - 130 4
Deferred income taxes (510) (1,696) 434
Changes in assets and liabilities, net of effects of
acquisition:
Accounts receivable (4,195) (5,366) (4,002)
Inventories (5,790) (2,840) (698)
Prepaid expenses and other 776 (563) 2,175
Accounts payable 4,178 (1,269) 1,329
Accrued liabilities 103 3,537 3,143
------------------------------------------
Net cash provided by operating activities 19,428 11,966 16,159
------------------------------------------
Investing Activities
Cash paid for acquisition - - (1,778)
Proceeds from sale of property, plant and equipment - 30 13
Proceeds from matured certificate of deposit 3,000 3,000 10,000
Investment in certificate of deposit (2,000) (1,000) (3,000)
Notes receivable, long-term - (75) -
Capital expenditures (17,781) (10,144) (16,976)
------------------------------------------
Net cash used in investing activities (16,781) (8,189) (11,741)
------------------------------------------
Financing Activities
Borrowings under revolving credit agreement 53,706 21,143 45,471
Payments under revolving credit agreement (53,706) (21,143) (50,827)
Payments on long-term debt (108) (108) -
Stock options exercised 1,256 820 478
Excess tax benefit from stock options exercised 1,852 - -
Repurchase of stock (3,855) (4,912) (4,979)
Cash dividends paid to stockholders (2,478) - -
------------------------------------------
Net cash used in financing activities (3,333) (4,200) (9,857)
------------------------------------------
Effects of exchange rate of cash 137 266 247
------------------------------------------
Net increase (decrease) in cash (549) (157) (5,192)
------------------------------------------
Cash and cash equivalents, beginning of year 837 994 6,186
------------------------------------------
Cash and cash equivalents, end of year $ 288 $ 837 $ 994
===========================================
The accompanying notes are an integral part of these statements.
-32-
AAON, Inc., and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2006
1. Business, Summary of Significant Accounting Policies and Other Financial Data
AAON, Inc. (the Company, a Nevada corporation) is engaged in the manufacture and
sale of air conditioning and heating equipment consisting of standardized and
custom rooftop units, chillers, air-handling units, make-up air units, heat
recovery units, condensing units, coils and boilers through its wholly-owned
subsidiaries, AAON, Inc. (AAON, an Oklahoma corporation), AAON Coil Products,
Inc. (ACP, a Texas corporation), and AAON Canada, Inc., d/b/a Air Wise (AAON
Canada, an Ontario corporation). AAON Properties, Inc., (an Ontario corporation)
is the lessor of property in Burlington, Ontario, Canada, to AAON Canada. The
consolidated financial statements include the accounts of the Company and its
subsidiaries, AAON, ACP, AAON Canada and AAON Properties Inc. All significant
intercompany accounts and transactions have been eliminated.
Currency
- --------
Foreign currency transactions and financial statements are translated in
accordance with Statement of Financial Standards No. 52, Foreign Currency
Translation. The Company uses the U.S. dollar as its functional currency, except
for the Company's Canadian subsidiaries, which use the Canadian dollar.
Adjustments arising from translation of the Canadian subsidiaries' financial
statements are reflected in accumulated other comprehensive income. Transaction
gains or losses that arise from exchange rate fluctuations applicable to
transactions denominated in Canadian currency are included in the results of
operations as incurred.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts in the consolidated financial
statements and accompanying notes.
The following accounting policies may involve a higher degree of estimation or
assumption:
Allowance for Doubtful Accounts - The Company establishes an allowance for
doubtful accounts based upon factors surrounding the credit risk of specific
customers, historical trends in collections and write-offs, current customer
status, the age of the receivable, economic conditions and other information.
Aged receivables are reviewed on a monthly basis to determine if the reserve is
adequate and adjusted accordingly at that time.
Inventory Reserves - The Company establishes a reserve for inventories based on
the change in inventory requirements due to product line changes, the
feasibility of using obsolete parts for upgraded part substitutions, the
required parts needed for part supply sales, replacement parts and for estimated
shrinkage.
Warranty - A provision is made for estimated warranty costs at the time the
product is shipped and revenue is recognized. The warranty period is: for parts
only, the earlier of one year from the date of first use or 14 months from date
of shipment; compressors (if applicable), an additional four years; on gas-fired
heat exchangers (if applicable), 15 years; and on stainless steel heat
exchangers (if applicable), 25 years. Warranty expense is estimated based on the
Company's warranty period, historical warranty trends and associated costs, and
any known identifiable warranty issue. Due to the absence of warranty history on
new products, an additional provision may be made for such products.
-33-
1. Business, Summary of Significant Accounting Policies and Other Financial Data
(continued)
Medical Insurance - A provision is made for medical costs associated with the
Company's Medical Employee Benefit Plan, which is primarily a self-funded plan.
A provision is made for estimated medical costs based on historical claims paid
and any known potential of significant future claims. The plan is supplemented
by employee contributions and an excess policy for claims over $100,000 per
claim.
Actual results could differ materially from those estimates.
Revenue Recognition
- -------------------
The Company recognizes revenues from sales of products at the time of shipment.
For sales initiated by independent manufacturer representatives, the Company
recognizes revenues net of the representatives' commission.
Acquisition
- -----------
On May 4, 2004, the Company (through AAON Canada, Inc.) acquired certain assets
and assumed certain liabilities of Air Wise Inc. of Mississauga, Ontario, Canada
for a total cost of $1,778,000. Air Wise is engaged in the engineering,
manufacturing, and sale of custom air-handling units, make-up air units and
packaged rooftop units for commercial and industrial buildings. The acquisition
complemented and expanded the products the Company manufactures and adds
significant additional capabilities for future growth. The purchase was paid for
by cash flow generated from operations. Subsequent to May 4, 2004, AAON Canada
Inc.'s activity is included in the Company's results of operations.
The Air Wise acquisition purchase price was allocated as of May 4, 2004, as
follows:
U.S.
Dollar
------------------
(in thousands)
Accounts receivable $ 1,087
Inventory 459
Fixed assets 277
Accrued warranty liability (45)
------------------
Total purchase price $ 1,778
==================
The Air Wise acquisition is not material for pro forma disclosure purposes.
On July 29, 2004, the Company (through AAON Properties, Inc.) purchased property
in Burlington, Canada, to relocate AAON Canada, Inc. The purchase will allow the
Company to enlarge and further expand its production capabilities. The purchase
price totaled $1,100,000.
-34-
1. Business, Summary of Significant Accounting Policies and Other Financial Data
(continued)
Concentrations
- --------------
The Company's customers are concentrated primarily in the domestic commercial
and industrial new construction and replacement markets. To date, virtually all
of the Company's sales have been to the domestic market, with foreign sales
accounting for less than 5% of revenues in 2006. At December 31, 2006 and 2005,
the two customers having the highest account balances represented approximately
3.5% and 1% respectively, of total accounts receivable.
Sales to customers representing 10% or greater of total sales consist of the
following:
Year Ended December 31,
2006 2005 2004
------------ ------------ ------------
Wal-Mart Stores, Inc. * * 14%
*Less than 10%
Cash and Cash Equivalents
- -------------------------
Cash and cash equivalents consist of bank deposits and highly liquid,
interest-bearing money market funds with initial maturities of three months or
less.
Accounts Receivable
- -------------------
The Company grants credit to its customers and performs ongoing credit
evaluations. The Company generally does not require collateral or charge
interest. The Company establishes an allowance for doubtful accounts based upon
factors surrounding the credit risk of specific customers, historical trends,
economic and market conditions and the age of the receivable. Past due accounts
are generally written off against the allowance for doubtful accounts only after
all collection attempts have been exhausted.
Accounts receivable and the related allowance for doubtful accounts are as
follows:
December 31,
2006 2005
-----------------------------------
(in thousands)
Accounts receivable $ 37,014 $ 33,172
Less: allowance for doubtful accounts (266) (685)
-----------------------------------
Total, net $ 36,748 $ 32,487
===================================
Year Ended December 31,
2006 2005 2004
---------------------------------------------------
(in thousands)
Allowance for doubtful accounts:
Balance, beginning of period $ 685 $ 717 $ 1,145
Provision for losses on accounts receivable 589 634 860
Adjustments to provision (648) (566) (339)
Accounts receivable written off, net of
recoveries (360) (100) (949)
--------------- ----------------- ---------------
Balance, end of period $ 266 $ 685 $ 717
=============== ================= ===============
-35-
1. Business, Summary of Significant Accounting Policies and Other Financial Data
(continued)
Inventories
- -----------
Inventories are valued at the lower of cost or market. Cost is determined by the
first-in, first-out (FIFO) method. The Company establishes an allowance for
excess and obsolete inventories based on product line changes, the feasibility
of substituting parts and the need for supply and replacement parts. Inventory
balances at December 31, 2006 and 2005, and the related changes in the allowance
for excess and obsolete inventories account for the three years ended December
31, 2006, are as follows:
December 31,
2006 2005
--------------------------------
(in thousands)
Raw materials $ 25,977 $ 18,256
Work in process 2,226 1,981
Finished goods 1,649 3,821
--------------- ---------------
29,852 24,058
Less: allowance for excess and obsolete inventories (350) (350)
--------------- ---------------
Total, net $ 29,502 $ 23,708
=============== ===============
Year Ended December 31,
2006 2005 2004
------------------------------------------------
(in thousands)
Allowance for excess and obsolete inventories:
Balance, beginning of period $ 350 $ 1,050 $ 1,050
Provision for excess and obsolete inventories - - -
Adjustments to reserve - (700) -
------------------------------------------------
Balance, end of period $ 350 $ 350 $ 1,050
================================================
At December 31, 2005, the Company had prepaid $776,000 for copper, at 2005
pricing, for 2006 material requirements. This amount is included as "prepaid
expenses and other" in the Company's Consolidated Balance Sheet at December 31,
2005. There were no prepaid materials as of December 31, 2006.
-36-
1. Business, Summary of Significant Accounting Policies and Other Financial Data
(continued)
Property, Plant and Equipment
- -----------------------------
Property, plant and equipment are stated at cost. Maintenance and repairs,
including replacement of minor items, are charged to expense as incurred; major
additions to physical properties are capitalized. Property, plant and equipment
are depreciated using the straight-line method over the following estimated
useful lives:
Description Years
- ------------------------------------------------------- ---------------
Buildings 10-30
Machinery and equipment 3-15
Furniture and fixtures 2-5
At December 31, property, plant and equipment were comprised of the following:
2006 2005
-------------------------------
(in thousands)
Land $ 2,196 $ 2,193
Buildings 31,272 28,953
Machinery and equipment 74,053 58,983
Furniture and fixtures 5,883 5,514
-------------------------------
113,404 95,643
Less: accumulated depreciation (54,182) (45,062)
-------------------------------
Total, net $ 59,222 $ 50,581
===============================
Impairment of Long-Lived Assets
- -------------------------------
The Company evaluates long-lived assets for impairment when events or changes in
circumstances indicate, in management's judgment, that the carrying value of
such assets may not be recoverable. When an indicator of impairment has
occurred, management's estimate of undiscounted cash flows attributable to the
assets is compared to the carrying value of the assets to determine whether
impairment has occurred. If an impairment of the carrying value has occurred,
the amount of the impairment recognized in the financial statements is
determined by estimating the fair value of the assets and recording a loss for
the amount that the carrying value exceeds the estimated fair value. Management
determined no impairment was required during 2006, 2005 and 2004.
Commitments and Contractual Agreements
- --------------------------------------
The Company is a party to several short-term, cancelable, fixed price contracts
with major suppliers for the purchase of raw material and component parts.
The Company has cancelable commitments to purchase machinery and equipment at a
cost of $4.8 million.
-37-
1. Business, Summary of Significant Accounting Policies and Other Financial Data
(continued)
Accrued Liabilities
- -------------------
At December 31, accrued liabilities were comprised of the following:
2006 2005
-------------------------------
(in thousands)
Warranty $ 5,572 $ 6,282
Commissions 6,862 8,037
Payroll 1,890 1,215
Income taxes - 623
Workers' compensation 494 555
Medical self-insurance 837 664
Other 403 451
-------------------------------
Total $ 16,058 $ 17,827
===============================
Warranties
- ----------
A provision is made for estimated warranty costs at the time the related
products are sold based upon the warranty period, historical trends, new
products and any known identifiable warranty issues. Warranty expense was $2.4
million, $3.6 million and $3.8 million for the years ended December 31, 2006,
2005 and 2004, respectively.
Changes in the Company's warranty accrual during the years ended December 31,
2006, 2005 and 2004 are as follows:
2006 2005 2004
-------------------------------------------
(in thousands)
Balance, beginning of the year $ 6,282 $ 6,301 $ 6,020
Payments made (3,128) (3,641) (3,493)
Warranties issued 4,343 3,622 3,774
Changes in estimate related to preexisting warranties (1,925) - -
-------------------------------------------
Balance, end of period $ 5,572 $ 6,282 $ 6,301
===========================================
The provision for warranties was decreased due to a change in estimate related
to preexisting warranties occurring in the fourth quarter of 2006. The change in
estimate was due to factors stated above, such as current information on
historical trends and a reduction in identifiable warranty issues.
-38-
1. Business, Summary of Significant Accounting Policies and Other Financial Data
(continued)
Earnings Per Share
- ------------------
The following table sets forth the computation of basic and diluted earnings per
share:
Years Ended,
2006 2005 2004
---------------------------------------------------------
(in thousands, except share and per share data)
Numerator:
Net income $ 17,133 $ 11,462 $ 7,521
================ ================ ================
Denominator:
Denominator for basic earnings per share-
Weighted average shares 12,304,072 12,339,998 12,435,473
Effect of dilutive stock options 348,331 409,800 487,896
---------------- ---------------- ----------------
Denominator for diluted earnings per
share -
Weighted average shares 12,652,403 12,749,798 12,923,369
================ ================ ================
Basic earnings per share $ 1.39 $ 0.93 $ 0.60
================ ================ ================
Diluted earnings per share $ 1.35 $ 0.90 $ 0.58
================ ================ ================
Anti-dilutive shares 155,500 115,250 72,250
================ ================ ================
Weighted average exercise price $ 24.82 $ 18.85 $ 19.40
================ ================ ================
Advertising
- -----------
Advertising costs are expensed as incurred. Advertising expense was $549,000,
$506,000 and $615,000 for the years ending December 31, 2006, 2005 and 2004,
respectively.
Research and Development
- ------------------------
Research and development costs are expensed as incurred. Research and
development expense was $1,974,000, $1,681,000 and $1,072,000 for the years
ending December 31, 2006, 2005 and 2004, respectively.
Shipping and Handling
- ---------------------
The Company incurs shipping and handling costs in the distribution of products
sold that are recorded in cost of sales. Shipping charges that are billed to the
customer are recorded in revenues.
Profit Sharing Bonus Plan
- -------------------------
The Company maintains a discretionary profit sharing bonus plan under which 10%
of pre-tax profit at each subsidiary is paid to eligible employees on a
quarterly basis in order to reward employee productivity. Eligible employees are
regular full-time employees who are actively employed and working on the first
day of the calendar quarter and remain continuously, actively employed and
working on the last day of the quarter and who work at least 80% of the quarter.
Profit sharing expense was $3,286,000, $2,075,000 and $1,408,000 for the years
ended December 31, 2006, 2005 and 2004, respectively.
-39-
Defined Contribution Plan - 401(k)
- ----------------------------------
The Company sponsors a defined contribution benefit plan. Eligible employees may
make contributions at a minimum of 1% and a maximum of 50% of compensation. In
addition, effective May 30, 2005, the Plan was amended to provide for automatic
enrollment in the Plan and provided for an automatic increase to the deferral
percent at January 1st of each year and each year thereafter, unless the
employee elects to decline the automatic increase and enrollment. Beginning with
pay periods after May 30, 2005, the one year enrollment waiting period was
waived. Administrative expenses paid by the Company for the plan were $85,300,
$68,600 and $69,900 for the years ended 2006, 2005 and 2004, respectively.
After January 1, 2006, the Company matching increased to 50% of the employee's
salary deferral up to the first 7% of compensation. Prior to January 1, 2006 the
Company matched 100% of the employee's salary deferral up to the first 3% of
compensation. The Company contributes in the form of cash and directs the
investment to shares of AAON Stock. No other purchases of AAON stock are
permitted. Employees are 100% vested in salary deferral contributions and vest
proportionately over 6 years in employer matching contributions. The Company
made matching contributions of $1,033,000, $775,000 and $546,000 in 2006, 2005
and 2004, respectively.
New Accounting Pronouncements
- -----------------------------
In November 2004, the FASB released SFAS No.151, Inventory Costs, an amendment
of Accounting Research Bulletin No. 43, Chapter 4, Inventory Pricing. The
Statement requires that abnormal amounts of idle facility expense, freight,
handling costs and spoilage should be expensed as incurred and not included in
overhead as an inventory cost. The new Statement also requires that allocation
of fixed production overhead costs should be based on normal capacity of the
production facilities. The Company adopted this Statement on January 1, 2006.
The adoption of this Statement did not have a material impact on the Company's
Consolidated Financial Statements.
In June 2005, the FASB issued SFAS 154, Accounting Changes and Error
Corrections, a replacement of APB Opinion No. 20, Accounting Changes, and FASB
Statement No. 3, Reporting Accounting Changes in Interim Financial Statements.
SFAS 154 changes the requirements for the accounting for and reporting of a
change in accounting principle. Previously, most voluntary changes in accounting
principles were required to be recognized via a cumulative effect adjustment
within net income of the period of the change. SFAS 154 requires retrospective
application to prior periods' financial statements, unless if it is
impracticable to determine either the period-specific effects or the cumulative
effect of the change. SFAS 154 is effective for accounting changes made in
fiscal years beginning after December 15, 2005; however, SFAS 154 does not
change the transition provisions of any existing accounting pronouncements. The
adoption of this Statement did not have a material impact on the Company's
Consolidated Financial Statements for the year ended 2006.
In July 2006, the FASB released FIN 48, Accounting for Uncertainty in Income
Taxes, an Interpretation of SFAS No. 109. FIN 48 clarifies the accounting for
uncertain tax positions as described in SFAS No. 109, Accounting for Income
Taxes, and requires a company to recognize, in its financial statements, the
impact of a tax position only if that position is "more likely than not" of
being sustained on an audit basis solely on the technical merits of the
position. FIN 48 also requires qualitative and quantitative disclosures
including a discussion of reasonably possible changes that might occur in the
recognized tax benefits over the next twelve months as well as a roll-forward of
all unrecognized tax benefits. FIN 48 is effective for fiscal years beginning
after December 15, 2006. Management is in the process of determining the effect
FIN 48 will have on the Company's Consolidated Financial Statements and
presently does not believe the adoption will have a material effect on the
Company's Consolidated Financial Statements.
In September 2006, the FASB released SFAS No. 157, Fair Value Measurements. SFAS
157 defines fair value and establishes a framework for measuring fair value in
generally accepted accounting principles, and expands disclosures about fair
value measurements. Although SFAS 157 applies to (and amends) the provisions of
existing authoritative literature, it does not, of itself, require any new fair
value measurements or establish valuation standards. SFAS 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. Adoption of SFAS 157 is not
expected to have a material impact on the Company's Consolidated Financial
Statements.
-40-
In September 2006, the staff of the Securities and Exchange Commission issued
SAB No. 108, Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial Statements. SAB 108 provides
interpretive guidance on the consideration of the effects of prior year
misstatements in quantifying current year misstatements for the purpose of a
materiality assessment. The Company adopted SAB 108 for the year ended December
31, 2006. The adoption did not have a material impact on the Company's
Consolidated Financial Statements as of December 31, 2006.
In February, 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities, which creates an alternative
measurement treatment for certain financial assets and financial liabilities.
SFAS 159 permits fair value to be used for both the initial and subsequent
measurements on an instrument by instrument basis, with changes in the fair
value to be recognized in earnings as those changes occur. This election is
referred to as the fair value option. SFAS 159 also requires additional
disclosures to compensate for the lack of comparability that will arise from the
use of the fair value option. SFAS 159 is effective for fiscal years beginning
after November 15, 2007. Adoption of SFAS 159 is not expected to have a material
impact on the Company's Consolidated Financial Statements.
In 2005, the FASB released SFAS 123(R), Share-Based Payment, which replaces SFAS
No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No.
25, Accounting for Stock Issued to Employees. The Statement requires measurement
of the cost of employee services received in exchange for an award of equity
instruments based on the grant-date fair value of the award. The compensation
cost will be recognized over the period of time during which an employee is
required to provide service in exchange for the award, which will be the vesting
period. The Statement applies to all awards granted and any unvested awards at
December 31, 2005. Effective January 1, 2006, the Company adopted the fair value
recognition method of SFAS No. 123(R) Share-Based Payment (SFAS 123R), using the
modified-prospective-transition method. The Company incurred $500,000 in
non-cash expenditures for the year ended December 31, 2006 due to the adoption
of SFAS 123(R).
Segments
- --------
Management has reviewed its business operations and determined that it operates
in a single homogeneous business segment as defined in SFAS 131, Disclosures
about Segments of an Enterprise and Related Information. The Company sells
similar products with similar economic characteristics to similar classes of
customers. The technologies and operations are highly integrated. Revenues and
costs are reviewed monthly by management on a product line basis as a single
business segment.
2. Supplemental Cash Flow Information
Interest payments of $81,000, $16,000 and $38,000 were made during the years
ending December 31, 2006, 2005 and 2004, respectively. Payments for income taxes
of $6,486,000, $7,189,000 and $3,977,000 were made during the years ending
December 31, 2006, 2005 and 2004, respectively. Dividends payable of $2,465,000
were accrued as of December 31, 2006 and paid on January 3, 2007.
3. Certificate of Deposit
At December 31, 2006 there were no investments in certificate of deposits. The
Company invested $500,000 in a 30-day certificate of deposit at January 31, 2006
bearing interest at 4.1% per annum. The Company reinvested the proceeds in April
of 2006 in a 60-day certificate of deposit bearing interest at 4.7% per annum.
At December 31, 2005, the Company had invested $1.0 million in a 30-day
certificate of deposit that bearing interest at 4% per annum. Proceeds from the
$1.0 million certificate of deposit were reinvested in April of 2006 in a 90-day
certificate of deposit bearing interest at 4.6% per annum. On June 12, 2004, the
Company had a $10.0 million certificate of deposit that matured bearing interest
at 3.25% per annum. Proceeds of $7.0 million were used for cash flow purposes
and a reinvestment of $3.0 million, and various amounts throughout the remainder
of the year, were invested in 30-day certificate of deposits. At December 31,
2004, the Company had invested $3.0 million in a 30-day certificate of deposit
bearing interest at 1.9% annum.
-41-
4. Revolving Credit Facility
The Company's revolving credit facility provides for maximum borrowings of $15.2
million which is provided by the Bank of Oklahoma, National Association. Under
the line of credit, there is one standby letter of credit totaling approximately
$600,000. The letter of credit was a requirement of the Company's workers
compensation insurance and has been renewed and will expire December 31, 2007.
Interest on borrowings is payable monthly at the Wall Street Journal prime rate
less 0.5% or LIBOR plus 1.6%, at the election of the Company (6.95% at December
31, 2006). No fees are associated with the unused portion of the committed
amount. At December 31, 2006, and December 31, 2005, the Company had no
borrowings outstanding under the revolving credit facility. Borrowings available
under the revolving credit facility at December 31, 2006, were $14.6 million.
The credit facility previously required the Company to maintain a certain
financial ratio and prohibited the declaration of cash dividends. On February
14, 2006, the Board of Directors voted to initiate a semi-annual cash dividend
of $0.20 per share to the holders of the outstanding Common Stock. In
conjunction with the Board's vote on February 14, 2006, the restriction of
payments of dividends was waived by the lender and removed from the covenants
with the renewal of the line of credit July 30, 2006. At December 31, 2006, the
Company was in compliance with its financial ratio covenants. On July 30, 2006,
the Company renewed the line of credit with a maturity date of July 30, 2007.
5. Debt
Short-term debt at December 31, 2006, consisted of notes payable totaling
$59,000 due in 2007, which are due in monthly installments of $9,004, with an
interest rate of 3.53%, related to a computer capital lease.
6. Income Taxes
The Company follows the liability method of accounting for income taxes, which
provides that deferred tax liabilities and assets are based on the difference
between the financial statement and income tax bases of assets and liabilities
using currently enacted tax rates.
The income tax provision consists of the following:
Year Ending December 31,
2006 2005 2004
--------------------------------------------
(in thousands)
Current $ 9,556 $ 8,566 $ 4,424
Deferred (491) (1,696) 434
-------------- -------------- --------------
$ 9,065 $ 6,870 $ 4,858
============== ============== ==============
The reconciliation of the federal statutory income tax rate to the effective
income tax rate is as follows: The 'Other' tax rate primarily relates to certain
domestic credits and the recognition of a portion of the Canadian valuation
allowance.
Year Ending December 31,
2006 2005 2004
--------------------------------------------
Federal statutory rate 35% 35% 35%
State income taxes, net of
federal benefit 4% 4% 5%
Other (4%) (2%) (1%)
--------------------------------------------
35% 37% 39%
============================================
-42-
The tax effect of temporary differences giving rise to the Company's deferred
income taxes at December 31 is as follows:
2006 2005 2004
-----------------------------------
(in thousands)
Net current deferred assets and (liabilities) relating to:
Valuation reserves $ 240 $ 391 $ 670
Warranty accrual 2,172 2,284 2,283
Other accruals 1,492 1,170 553
Other, net 50 32 31
-----------------------------------
$ 3,954 $ 3,877 $ 3,537
===================================
Net long-term deferred (assets) and liabilities relating to:
Depreciation and amortization $ 5,492 $ 5,027 $ 5,830
NOL (1,242) (695) -
Share-based compensation (189) 142 -
-----------------------------------
$ 4,061 $ 4,474 $ 5,830
===================================
The Net Operating Loss ("NOL") Deferred Tax Asset relates to AAON Canada.
Expiration of NOL's originating in 2006 and 2005 will occur in twenty and nine
years, respectively.
7. Stock-Based Compensation
The Company maintains a stock option plan for key employees, directors and
consultants. The Company's stock option plan provided for 2,925,000 shares of
common stock to be issued under the plan. Under the terms of the plan, the
exercise price of shares granted may not be less than 85% of the fairmarket
value at the date of the grant. Options granted to directors prior to May 25,
2004, vest one year from the date of grant and are exercisable for nine years
thereafter. Options granted to directors on or after May 25, 2004, vest
one-third each after 1-3 years. All other options granted vest at a rate of 20%
per year, commencing one year after date of grant, and are exercisable during
years 2-10.
Prior to January 1, 2006, the Company accounted for its nonqualified stock
options under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. Under APB
25, no stock-based employee compensation cost was reflected in net income, as
all options granted under the plan qualified for "fixed" plan accounting and had
an exercise price equal to the market value of the underlying common stock on
the date of grant. The Company had adopted the disclosure-only provisions of
SFAS No. 123, Accounting for Stock-Based Compensation. No stock based
compensation cost was recognized in the Consolidated Statements of Income for
the years ended December 31, 2005 and 2004.
Effective January 1, 2006, the Company adopted the fair value recognition
provisions of SFAS No. 123(R), Share-Based Payment, using the
modified-prospective transition method. Under that transition method,
compensation cost recognized for the year ended December 31, 2006 includes all
share-based payments granted prior to, but not yet vested as of January 1, 2006,
and compensation cost for all share-based payments granted subsequent to January
1, 2006. The compensation cost is based on the grant date fair value calculated
using a Black-Scholes-Merton Option Pricing Model in accordance with provisions
of SFAS 123(R).
For the year ended December 31, 2006, the Company recognized approximately
$500,000 in pre-tax compensation expense in the Consolidated Statement of Income
related to the stock option plan. The total pre-tax compensation cost related to
nonvested stock options not yet recognized as of December 31, 2006, is $1.8
million and is expected to be recognized over a weighted-average period of 2.5
years.
Prior to the adoption of SFAS 123(R), the Company presented all tax benefits
resulting from the exercise of stock options as operating cash flows in the
Consolidated Statement of Cash Flows. Statement 123(R) requires that cash flows
from the exercise of stock options resulting from tax benefits in excess of
recognized cumulative compensation cost (excess tax benefits) be classified as
financing cash flows. For the year ended December 31, 2006, $1,852,000 of such
excess tax benefits from share-based payment plans was classified as financing
cash flows.
-43-
For the years ended December 31, 2006, 2005 and 2004, the Company reduced its
income tax payable by $1,852,000, $750,000 and $476,000, respectively, as a
result of nonqualified stock options exercised under the Company's stock option
plan.
The effect on net income and earnings per share if the Company had applied the
fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, to stock-based employee compensation in prior years is as follows:
Year Ended December 31,
2005 2004
----------------------------------
(in thousands except per share
data)
Net income, as reported $ 11,462 $ 7,521
Deduct: Total stock-based employee compensation
expense determined under fair value method
for all awards, net of related tax effects (438) (298)
----------------------------------
Pro forma net income $ 11,024 $ 7,223
==================================
Earnings per share:
Basic, as reported $ 0.93 $ 0.60
==================================
Basic, pro forma $ 0.89 $ 0.58
==================================
Diluted, as reported $ 0.90 $ 0.58
==================================
Diluted, pro forma $ 0.86 $ 0.56
==================================
The following assumptions were used to determine the fair value of the unvested
stock options on the original grant date for expense recognition purposes for
options granted during the year ended December 31, 2006 and for pro forma
disclosure purposes for the years ended December 31, 2005 and 2004:
2006 2005 2004
------------- ------------- -------------
Directors and Officers:
Expected dividend yield 1.71% - -
Expected volatility 36.48% 32.15% 36.70%
Risk-free interest rate 5.15% 4.39% 4.24%
Expected life 8.0 yrs 8.0 yrs 8.0 yrs
Forfeiture Rate 0% 0% 0%
Employees:
Expected dividend yield 1.71% - -
Expected volatility 40.78% 32.15% 36.70%
Risk-free interest rate 4.78% 4.39% 4.24%
Expected life 6.30 yrs 8.0 yrs 8.0 yrs
Forfeiture Rate 28% 0% 0%
The expected term of the options is based on evaluations of historical and
expected future employee exercise behavior. The risk-free interest rate is based
on the U.S. Treasury rates at the date of grant with maturity dates
approximately equal to the expected life at the grant date. Volatility is based
on historical volatility of the Company's stock. The Company had not declared
dividends in prior years, but initiated a dividend payout in 2006. The Company
used board approved semi-annual dividend payouts of $0.20 per share to calculate
the expected dividend yield.
-44-
The following is a summary of stock options outstanding as of December 31, 2006:
Options Outstanding Options Exercisable
--------------------------------------------------------------- ----------------------------------
Range of Number Weighted Weighted Aggregate Number Weighted
Exercise Prices Outstanding at Average Average Intrinsic Exercisable at Average
December 31, Remaining Exercise Value December 31, 2006 Exercise
2006 Contractual Price Price
Life
- --------------------------------------------------------------------------------------------------------------------------
2.33 - 3.39 250,825 0.48 $ 3.26 $ 23.02 250,825 $ 3.26
4.00 - 5.78 256,580 2.43 5.00 21.28 256,580 5.00
8.59 - 16.94 182,175 5.81 12.60 13.68 124,375 11.06
17.10 - 18.90 50,000 8.51 17.71 8.57 12,740 17.74
19.02 - 21.84 81,250 6.53 19.93 6.35 52,490 19.47
23.32 - 27.65 153,500 9.63 24.90 1.38 - -
-----------------------------------------------------------------------------------------------------
Total 974,330 4.35 $ 11.00 $ 15.28 697,010 $ 6.78
=====================================================================================================
A summary of option activity under the plan as of December 31, 2006, is as
follows:
Weighted
Weighted Average Aggregate
Average Remaining Intrinsic Value
Options Shares Exercise Price Contractual Term ($000)
---------------- -------------------- ----------------- ------------------
Outstanding at December 31, 2003 1,227,330 $ 5.70
Granted 31,000 19.58
Exercised (94,950) 4.99
Forfeited or Expired (3,600) 5.78
---------------- --------------------
Outstanding at December 31, 2004 1,159,780 $ 6.13
Granted 133,000 16.63
Exercised (162,400) 5.05
Forfeited or Expired (16,700) 8.37
---------------- --------------------
Outstanding at December 31, 2005 1,113,680 $ 7.51
Granted 179,500 24.42
Exercised (271,300) 4.63
Forfeited or Expired (47,550) 16.67
---------------- --------------------
Outstanding at December 31, 2006 974,330 11.00 4.35 $ 14,888
================ ==================== ================= ==================
Exercisable at December 31, 2006 697,010 $ 6.78 2.49 $ 13,593
================ ==================== ================= ==================
The weighted average grant date fair value of options granted during 2006 was
$9.88. The total intrinsic value of options exercised during the year ended
December 31, 2006 was $4.97 million. The cash received from options exercised
during the year ended December, 2006 was $1.26 million. The impact of these cash
receipts is included in financing activities in the accompany Consolidated
Statements of Cash Flows.
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A summary of the status of the non-vested shares as of December 31, 2006, is as
follows:
Weighted Average Grant
Shares Date Fair Value
------------------ ----------------------------
Nonvested at January 1, 2006 197,420 $ 7.73
Granted 179,500 $ 9.88
Vested (54,300) $ 7.24
Forfeited (45,300) $ 8.18
------------------
Nonvested at December 31, 2006 277,320 $ 9.13
==================
The total fair value of shares vested during the year ended December 31, 2006
was $432,000.
8. Stockholder Rights Plan
During 1999, the Board of Directors adopted a Stockholder Rights Plan (the
"Plan"), which was amended in 2002. Under the Plan, stockholders of record on
March 1, 1999, received a dividend of one right per share of the Company's
common stock. Stock issued after March 1, 1999, contains a notation
incorporating the rights. Each right entitles the holder to purchase one
one-thousandth (1/1,000) of a share of Series A Preferred Stock at an exercise
price of $90. The rights are traded with the Company's common stock. The rights
become exercisable after a person has acquired, or a tender offer is made for,
15% or more of the common stock of the Company. If either of these events
occurs, upon exercise the holder (other than a holder owning more than 15% of
the outstanding stock) will receive the number of shares of the Company's common
stock having a market value equal to two times the exercise price.
The rights may be redeemed by the Company for $0.001 per right until a person or
group has acquired 15% of the Company's common stock. The rights expire on
August 20, 2012.
9. Stock Repurchase
Following repurchases of approximately 12% of its outstanding Common Stock
between September 1999 and September 2001, the Company announced and began its
current stock repurchase program on October 17, 2002, targeting repurchases of
up to an additional 10% (1,325,000 shares) of its outstanding stock. Through
December 31, 2006, the Company had repurchased a total of 1,257,864 shares under
the current program for an aggregate price of $22,034,568, or an average of
$17.52 per share. On February 14, 2006, the Board of Directors approved the
suspension of the Company's repurchase program.
On July 1, 2005, the Company entered into a stock repurchase arrangement by
which employee participants in AAON's 401(k) savings and investment plan are
entitled to have shares of AAON stock in their accounts sold to the Company to
provide diversification of their investments. Through December 31, 2006, the
Company repurchased 246,551 shares for an aggregate price of $5,185,000 or an
average price of $21.03 per share.
10. Dividends
On February 14, 2006, the Board of Directors voted to initiate a semi-annual
cash dividend of $0.20 per share to the holders of the outstanding Common Stock
of the Company to be declared at dates of the Board's discretion. In 2006,
dividends were declared to shareholders of record at the close of business on
June 12, 2006 and paid on July 3, 2006 and declared to shareholders of record at
the close of business on December 11, 2006 and paid on January 3, 2007. The
Company paid cash dividends of $2,478,000 and declared dividends payable of
$2,465,000 for the year ended December 31, 2006.
11. Contingencies
The Company is subject to claims and legal actions that arise in the ordinary
course of business. Management believes that the ultimate liability, if any,
will not have a material effect on the Company's results of operations or
financial position.
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12. Quarterly Results (Unaudited)
The following is a summary of the quarterly results of operations for the years
ending December 31, 2006 and 2005:
Quarter Ended
March 31 June 30 September 30 December 31
---------------------------------------------------------------------------
(in thousands, except per share data)
2006
Net sales $ 53,620 $ 59,137 $ 64,153 $ 54,550
Gross profit 10,384 10,119 13,591 9,796
Net income 3,743 3,455 5,397 4,538
Earnings per share:
Basic 0.30 0.28 0.44 0.37
Diluted 0.30 0.27 0.43 0.35
Quarter Ended
March 31 June 30 September 30 December 31
---------------------------------------------------------------------------
(in thousands, except per share data)
2005
Net sales $ 42,780 $ 45,394 $ 48,136 $ 48,885
Gross profit 10,050 8,372 8,643 8,226
Net income 3,287 3,125 2,766 2,284
Earnings per share:
Basic 0.27 0.25 0.22 0.19
Diluted 0.26 0.24 0.22 0.18
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